Portfolio Manager Commentary
Overview, strategy, and outlook: As of January 31, 2018
U.S. government sector
Like the horror-film villain that just won’t die, the debt ceiling continues to be an issue in the money markets. Its current incarnation comes with an odd mix of unusual uncertainty regarding cash-flow timing and, conversely, perhaps more clarity politically. From a cash-flow standpoint, the U.S. Treasury usually has a pretty good read on its expected cash flows, both in and out. In this case, while the out likely will follow the formulas for tax refunds, benefit payments, and operations, the in is completely murky, as the main inflows—tax deposits—are set to change as employees and employers adjust their withholdings and companies recompute their estimated tax payments to align them with the big new tax law.
The identity of the X-date, the exact date when the debt ceiling would bind because the Treasury had exhausted its extraordinary measures and had run out of cash with bills to pay, remains a mystery! On the one hand, the Treasury issued the following statement on January 31, which doesn’t quite name a specific date:
“Based upon available information, Treasury expects to be able to fund the government through the end of February.”
That same day, the Congressional Budget Office (CBO) wrote:
“CBO estimates that unless the debt limit is increased, by using all available extraordinary measures, the Treasury will probably have sufficient cash to make its usual payments until sometime in the first half of March 2018, although an earlier or later date is possible.”
On the other hand, while we don’t claim any political expertise, on the face of it, the fact that both houses of Congress and the presidency are ostensibly controlled by people who belong to and attend the same party(ies) suggests that a political resolution is a friendlier proposition than when the institutions were at loggerheads a few years ago. Yes, there remain obstacles, as factions of each party have their particular axes to grind, but the passage of the tax-overhaul bill in December suggests that a way can be found.
To summarize, conditions favor a timely resolution, at least compared with the usual dismal circus, but we don’t know when the resolution is needed. Nor do we know the length of the anticipated relief.
Aside from the debt ceiling, the government money markets seem to have roundly embraced the booming economy and likelihood of resulting future interest-rate hikes. As shown in the chart below of market rates on Treasury bills and government-sponsored enterprise discount notes since the Federal Reserve (Fed) began raising rates in 2015, rates on those securities generally have not strayed too far from the rate on the Fed’s overnight reverse repurchase agreement (RRP) program until the next rate hike approached. They moved away from the RRP line in early October 2017 as the market began looking ahead to the December rate hike, and the RRP line has been in the rearview mirror ever since, with the market looking ahead to the next hike with the ink not yet dry on the last one.
Government security 3-month yields
Source: Bloomberg L.P.
The lead-up to the Federal Open Market Committee (FOMC) meeting on January 31 was fairly benign in terms of market expectations; however, it was significant, as it was the final meeting being chaired by Janet Yellen, marking the end of her tenure as Fed chair. As expected, the FOMC chose to keep its target rate range unchanged after raising the target rate range to 1.25% to 1.50% in December.
The corresponding policy statement showed the FOMC seemed comfortable in characterizing gains in employment, household spending, and business investment as solid, while the unemployment rate is stable at current low levels rather than continuing to fall. On the inflation front, the FOMC changed its view to one where inflation will move up this year and stabilize around the 2% objective in the medium term. This is a slight modification to the prior view that it will remain below 2% in the near term but still improve in the medium term, as well as an indication that the FOMC feels better about the current inflation outlook, despite data that has not yet reflected much price or wage growth. The statement of economic risk was not changed and remained roughly balanced.
Subject to a meaningful change economically, the transition to Jerome Powell taking over as the new Fed chair was seamless and a refreshing change in our current environment. Chair Powell’s leadership is widely expected to be a continuation of the market-friendly tenures of Chair Yellen and Chair Bernanke.
During Janet Yellen’s four-year tenure as Fed chair, some interesting developments occurred:
- - The FOMC’s target rate increased from 0% to a range of 1.25% to 1.50%.
- - The unemployment rate fell from 6.7% to 4.1%.
- - The core personal consumption expenditures index1 declined further from 1.55% to 1.52%.
- - Yields on 2-year Treasury notes increased from 0.30% to 2.15%.
- - The 10-year Treasury note yield increased from 2.58% to 2.73%
Economic conditions in the U.S. and internationally continue to be positive, and the FOMC statement appeared to agree with that assessment, reinforcing market participants’ beliefs that the Fed will continue on its tightening path. Current market expectations and the Summary of Economic Projections have the FOMC increasing its target rate three or four times in 2018.
What does all this have to do with money markets? As economic data improves and market participants continue to expect the FOMC to maintain its tightening bias, money market yields adjust higher, reflecting higher future rates. As the chart below demonstrates, the London Interbank Offered Rate (LIBOR) curve continues to steepen. During January, one-month LIBOR increased 1 basis point (bp; 100 bps equal 1.00%), three-month LIBOR rose 8 bps, and one-year LIBOR increased 25 bps. As the FOMC approaches its terminal rate, these curves have a tendency to flatten or even invert.
LIBOR yield curves
Source: Bloomberg L.P.
For prime money market funds, the gradual pace of Fed tightening has enabled managers of those assets to opportunistically extend weighted average maturities (WAMs)2 and weighted average lives (WALs)3 to take advantage of what yield pickup there is from extension out the curve. The average maturity for institutional prime funds has hovered in the mid-20s for the past several months. Our funds’ WAMs have been slightly lower at around 15 days recently (with WALs closer to 57 days) in an effort to maintain increased amounts of liquidity and to be in a position to more quickly capture the effects of future rate hikes. In addition, this positioning has allowed our prime funds to maintain a significant yield pickup over respective government funds and a high degree of interest-rate sensitivity. As the chart below demonstrates, adding incremental position in the form of longer-dated commercial paper continues to provide shareholders with an enhanced yield proposition.
Money market yield curves
Sources: Wells Capital Management Inc. and Bloomberg L.P.
While rates in general continue to drift higher, we believe our investment strategy of emphasizing highly liquid portfolios, relatively short WAMs, and a position in securities that reset frequently will allow us to capture future FOMC rate moves with minimal net asset value (NAV) pricing pressures.
Wells Fargo FNAV money market fund NAVs
Source: Wells Fargo Funds
Wells Fargo FNAV money market fund weekly liquid assets
Source: Wells Fargo Funds
Municipal money market yields fell back to earth during the month of January as strong seasonal reinvestment cash reignited demand for tax-exempt paper throughout the short end of the curve. An accompanying drop in new-issue supply from December’s record-setting pace exacerbated the dramatic shift in market dynamics. Yields on variable-rate demand notes (VRDNs) and tender option bonds (TOBs) in the overnight and weekly space, which had experienced the highest degree of volatility during the month of December, quickly began to normalize to more reasonable ratios relative to taxables during the month.
The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index,4 which had spiked to a multiyear high of 1.71% (116% of one-week LIBOR) during the month of December, quickly shifted into downward mode. The index fell for five consecutive weeks before eventually closing out the month at 1.08% (73% of one-week LIBOR). Strong reinvestment demand extended further out on the municipal curve, driving yields on tax-exempt commercial paper, notes, and bonds lower as well. Ultimately, yields on high-grade one-year notes finished out the month at 1.40%, down from 1.46% at year-end.
During the month, we continued to emphasize principal preservation and liquidity by targeting our purchases in VRDNs and TOBs with daily and weekly puts. Despite the rapid but expected drop in rates in the short end during the month, we continue to feel that this sector of the curve offers compelling nominal and after-tax return for municipal investors. Additionally, we continue to feel that a focus on liquidity and principal preservation is prudent, particularly given the relative flatness of the municipal money market yield curve and increasing prospects for further monetary policy tightening in 2018.
On the horizon
February promises to be an eventful month for policy wonks. As noted above, we believe odds favor a resolution to the debt-ceiling constraints; we do not, however, believe that the process will be free of drama. But also in February—on the 8th, to be exact—the government may face the prospect of another shutdown if a spending resolution is not passed. Though the Republicans hold a nominal majority, as noted above that majority is prone to dissolving into factions seeking different goals. Add to the mix midterm elections later this year as well as a seemingly unified Democratic party that has become increasingly disinclined to work with its compatriots across the aisle on anything that may be viewed as a triumph for Trump, and you have the ingredients for high drama and lots of finger-pointing. Hopefully, the money markets will continue to be an oasis of calm in a chaotic world and any impacts are minimal and short-lived.
Rates for sample investment instruments—Current month-end % (January 2018)
|Sector||1 day||1 week||1 month||2 month||3 month||6 month||12 month||Wells Fargo Fund||7 day current yield|
|U.S. Treasury repos||1.34||1.32||–||–||–||–||–||Cash Investment*–Select shares||1.53|
|Fed reverse repo rate||1.25||–||–||–||–||–||–||Heritage*-Select shares||1.53|
|U.S. Treasury bills||–||–||1.38||1.31||1.46||1.65||1.88||Municipal Cash Mgmt*–Inst'l shares||0.97|
|Agency discount notes||0.99||1.04||1.18||1.31||1.40||1.52||1.88|
|Asset-backed commercial paper||1.43||1.47||1.58||1.70||1.79||1.99||–||Treasury Plus**-Inst'l shares||1.17|
|Dealer commercial paper||1.32||1.31||1.43||1.55||1.66||1.81||–||100% Treasury**-Inst'l shares||1.17|
Sources: Bloomberg L.P., Wells Capital Management, Inc., and Wells Fargo Funds
Figures quoted represent past performance, which is no guarantee of future results, and do not reflect taxes that a shareholder may pay on a fund. Yields will fluctuate. Current performance may be lower or higher than the performance data quoted and assumes the reinvestment of dividends and capital gains. Current month-end performance is available at the funds’ website, wellsfargofunds.com.
Money market funds are sold without a front-end sales charge or contingent deferred sales charge. Other fees and expenses apply to an investment in the fund and are described in the fund’s current prospectus.
The manager has contractually committed to certain fee waivers and/or expense reimbursements. Brokerage commissions, stamp duty fees, interest, taxes, acquired fund fees and expenses, and extraordinary expenses are excluded from the cap. Without these reductions, the seven-day current yield for the Institutional Class of the Cash Investment Money Market Fund, Heritage Money Market Fund, Municipal Cash Management Money Market Fund, Government Money Market Fund, Treasury Plus Money Market Fund, and 100% Treasury Money Market Fund would have been 1.40%, 1.40%, 0.89%, 1.16%, 1.15%, and 0.96%, respectively, and the total returns would have been lower. The cap may be increased or the commitment to maintain the cap may be terminated only with the approval of the Board of Trustees. The expense ratio paid by an investor is the net expense ratio or the total annual fund operating expense after fee waivers, as stated in the prospectus.
1. The Personal Consumption Expenditures (PCE) Index is the primary measure of consumer spending on goods and services in the U.S. economy. It accounts for about two-thirds of domestic final spending and is part of the personal income report issued by the Bureau of Economic Analysis of the Department of Commerce. The core of the index excludes food and energy prices. You cannot invest directly in an index.
2. Weighted average maturity (WAM): An average of the effective maturities of all securities held in the portfolio, weighted by each security’s percentage of total investments. The maturity of a portfolio security is the period remaining until the date on which the principal amount is unconditionally required to be paid, or in the case of a security called for redemption, the date on which the redemption payment is unconditionally required to be made. WAM calculations allow for the maturities of certain securities with demand features or periodic interest-rate resets to be shortened. WAM is a way to measure a fund’s sensitivity to potential interest-rate changes. WAM is subject to change and may have changed since the date specified.
3. Weighted average life (WAL): An average of the final maturities of all securities held in the portfolio, weighted by their percentage of total investments. The maturity of a portfolio security is the period remaining until the date on which the principal amount is unconditionally required to be paid, or in the case of a security called for redemption, the date on which the redemption payment is unconditionally required to be made. The calculation of WAL allows for the maturities of certain securities with demand features to be shortened but, unlike the calculation of WAM, does not allow shortening of the maturities of certain securities with periodic interest-rate resets. WAL is a way to measure a fund’s potential sensitivity to credit spread changes. WAL is subject to change and may have changed since the date specified.
4. The SIFMA Municipal Swap Index is a seven-day high-grade market index composed of tax-exempt variable-rate demand obligations with certain characteristics. The index is calculated and published by Bloomberg. The index is overseen by SIFMA’s Municipal Swap Index Committee. You cannot invest directly in an index.
*For floating NAV money market funds: You could lose money by investing in the fund. Because the share price of the fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.
For retail money market funds: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.
**For government money market funds: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.
For the municipal money market funds, a portion of the fund’s income may be subject to federal, state, and/or local income taxes or the alternative minimum tax. Any capital gains distributions may be taxable. For the government money market funds, the U.S. government guarantee applies to certain underlying securities and not to shares of the fund.
The views expressed and any forward-looking statements are as of January 31, 2018, and are those of the fund managers and the Money Market team at Wells Capital Management, subadvisor to the Wells Fargo Money Market Funds, and Wells Fargo Funds Management, LLC. Discussions of individual securities, the markets generally, or any Wells Fargo Funds are not intended as individual recommendations. Future events or results may vary significantly from those expressed in any forward-looking statements; the views expressed are subject to change at any time in response to changing circumstances in the market. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.
Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. For a current prospectus and, if available, a summary prospectus, containing this and other information, visit wellsfargofunds.com. Read it carefully before investing.