skip navigation

Mark Lindbloom

The Fed and Liquidity Markets:
Maintaining Balance

Mark Lindbloom
Portfolio Manager
Kevin Kennedy
Head of Liquidity Portfolio Management
Matt Jones, CFA
Head of Liquidity Distribution

In the latest quarterly webcast, Matt Jones, alongside portfolio managers Mark Lindbloom and Kevin Kennedy, discussed the impact of Federal Reserve policy on liquidity and fixed-income investments in light of recent stubborn inflation data and resilient economic indicators. Mark Lindbloom provided an overview of market sentiment changes, attributing them to stronger-than-expected economic performance and persistent inflation, while maintaining a base case scenario of moderating growth and inflation for the remainder of the year. Kevin Kennedy discussed the effects of Treasury issuance and the reduction of the Fed’s reverse repo program on money markets, emphasizing a cautious approach due to Fed policy uncertainty and new SEC regulations that increase liquidity requirements for money market funds. The webcast concluded with a discussion on the potential impact of the upcoming election year on federal policy, with Mark Lindbloom generally unconcerned about significant changes to the Fed’s approach under a new administration.

Shift in Market Sentiment Regarding Interest Rates

  • As the year began, the market expected six to seven cuts in the federal funds overnight target rate over the course of 2024, but recent data suggests expectations have shifted to one or two.
  • We believe the shift was due to economic resiliency with growth expectations at 1.5% to 2.0%; strong payroll and higher than expected consumer spending.
  • Our base case continues to be a moderation in inflation and growth

Effect of Shift on Expectations on Money Markets

  • The short end of the money market has closely followed the Federal Reserve (Fed) rate expectations.
  • There continues to be extremely strong demand for bills from both US and offshore investors.
  • Attractive Treasury bill yields have led to a decrease in the use of the Fed’s reverse repo program (RRP), a key tool the Fed uses to maintain stability in the money markets.
  • There’s a consensus that the Fed may have finished raising rates, though with data continuing to reflect stubborn stickiness in inflation, some speculate about a resumption of tightening.
  • Any increase in yields is seen as a chance to extend fund maturities, with current levels for short-term investors remaining attractive.

Thoughts on the Likelihood of the Fed Raising Rates in 2024

  • Western Asset’s investment process considers a base case scenario as well as alternative outcomes.
  • Our Base Case Scenario assumes slower growth in 2024 without a recession and inflation falling to around 2% by the end of the year.
  • Alternative Scenarios include a left-hand tail with a significant economic slowdown or recession, and a right-hand tail with stronger-than-expected growth—which is closer to what we’re seeing lately.
  • Western Asset’s positioning strategy is conservative in the stronger growth scenario, adjusting duration and yield curve positioning in portfolios.
  • Our base case remains moderate growth and inflation, but we remain vigilant and ready to adjust strategies if necessary.

Changes in Money Markets

  • Western Asset has no immediate concerns regarding the current dynamics in the liquidity markets and their impact on fund portfolio management despite money market investors having largely moved away from the RRP into Treasury bills due to the very large quantities of bills issued by the Treasury department as well as because of the expectations for strong collections this tax season. The RRP is now less than $500 billion from its height of well-above $2 trillion in 2022.
  • The Fed is keen to avoid a repeat of the 2019 disruptions in the repo markets caused by reserve imbalances, and is taking a number of measures to mitigate this risk, including slowing down the roll-off of Treasuries and mortgage-backed securities from the Fed’s balance sheet.
  • Overall, the Firm has confidence in the current state of liquidity markets, with no significant concerns, and emphasizes the importance of the Fed’s role in maintaining market stability.

Long-Term Positioning

  • Western Asset’s investment process is built on valuations, conviction in market pricing, and diversification. These principles have guided the Firm for 50 years.
  • We see opportunities in actively managing fixed-income sectors to attractive yields, which range from 5.5% to 7%, depending on duration.
  • We believe that bonds will return to their traditional role as a stabilizer in portfolios, offsetting volatility in other asset classes.
  • While recent optimism has prevailed in the economy and equity markets, there is a need for caution. Valuations in non-sovereign paper are okay, but spreads over Treasury are less compelling, especially in the investment-grade market.
  • Western Asset is shifting toward higher quality structured sectors such as mortgages and asset-backed securities, balancing the portfolio for all-weather conditions.
  • The Firm is positive on specific emerging markets, particularly local markets and currencies, where valuations remain attractive.
  • We emphasize diversification and consider rates to be attractive, and we advocate a balanced, conservative approach in light of current concerns.

Money Market Funds and New SEC Regulations on Liquidity

  • The SEC has mandated new liquidity requirements for US money market funds, increasing daily liquidity to 25% and weekly liquidity to 50%, up from 10% overnight and 30% weekly.
  • Western Asset believes the amended liquidity regulations could lead to somewhat less attractive returns for MMF investors in the future, especially those favoring prime money market funds for their higher yields compared to government funds.
  • Other changes, including Mandatory Liquidity Fees for prime MMFs, may contribute to the growth of government funds which will continue to be represent an important demand source for Treasury issuance. In turn, this increased demand may, potentially lead to lower Treasury bill yields over time.
  • Despite the new rules, we continue to manage our funds with a high level of liquidity due to Fed uncertainty, and this conservative approach will persist.

Election Impact on Fed Policy

  • There are debates about the fiscal policies of a potential Biden or Trump administration, with concerns about how each might address the deficit—Biden possibly through tax increases and Trump potentially leading to even higher deficits.
  • Tariffs are another point of discussion, especially under a Trump administration, which could impose tariffs on China and other countries, affecting budget deficits, economic growth and inflation. However, campaign rhetoric often does not translate into drastic policy changes.
  • Speculation about the future of Fed Chair Powell and the Fed’s independence is a topic of conversation. We dismiss concerns about the Fed’s compliance with presidential wishes, citing institutional memory and regulations that safeguard its independence. Even if Powell were replaced, some potential candidates are considered more hawkish.

© Western Asset Management Company, LLC 2024. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").
Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.
These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.
Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.
Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.
Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.
These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.
Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.