A rosy view

Market outlook

• Information contained in the Federal Open Market Committee’s (FOMC or the Committee) Summary of Economic Projections released at the March meeting reflected a potential paring back of policy restraint this year despite a more sanguine outlook for economic growth and employment and a modest uptick in projected core inflation.
• Based on this information, we expect the FOMC will eventually move to adjust the federal funds rate lower in a gradual fashion should core inflation continue to moderate.
• Net Treasury bill (T-bill) issuance should abate following heavy supply over the past few quarters, while expectations around the timing and extent of any rate cuts by the Federal Reserve ( the Fed) will, in our view, influence the level of utilization of the New York Federal Reserve’s overnight repurchase agreement program (RRP).

Q1 highlights

• The FOMC maintained the range for the federal funds target rate at 5.25% to 5.50% during the first quarter as it continued in our view to cautiously assess the effects of its policy firming to date.
• In a statement² released in conjunction with the March meeting, the Committee noted that inflation “remains elevated” while acknowledging that it has “eased over the past year.” The statement also recognized the “solid pace” of economic growth.
• The March meeting statement also highlighted that the FOMC views “risks to achieving its employment and inflation goals” as becoming more balanced.

In contrast to the increase in government MMF assets across the industry, BlackRock government funds experienced slight net outflows during the first quarter.

Short-term Treasury rates fluctuated throughout the quarter, as market expectations for rate cuts were reduced and pushed out. The 1-month and 2-month Treasury bills ended the period down 6 basis points at 5.49% and 5.48%, respectively, while yield levels on all other tenors increased or remained stable. The 6-month T-bill hit a high of 5.39% during the quarter and finished the period slightly lower at 5.38%.

Yields on the 1-year tenor closed the quarter up 23 basis points at 5.03%, slightly below the quarter high of 5.06%.³ Repo exposures increased over the period to maintain ample liquidity while extending duration. With respect to adding duration, we are targeting a longer WAM profile as we now view fixed rate extensions as providing fairly attractive valuation now that the FOMC has moved to a balanced risk outlook and the macro-economic environment has stabilized relative to last year. At the start of the quarter, weighted average maturities (WAMs) in our government funds hovered near 35 days for repo-eligible funds and 46 days for non-repo funds. By the end of the quarter, these figures edged up to 45 and 49 days, respectively.

Purchases throughout the quarter were mostly comprised of 2-month T-bills at an average yield of 5.40% and 6-to-12- month T-bills at an average yield of 5.20%.⁴

Year to date, markets received approximately $687 billion of front-end Treasury supply, with a heavy skew towards bills. Following tax season, projected issuance is expected to be more skewed towards coupons.⁵

While eligible funds continued to utilize the Fed RRP throughout the period, aggregate usage of the facility steadily declined throughout the period as investors who favored the Fed RRP as an alternative to short-dated government securities began to rotate into new Treasury supply post-debt ceiling resolution and dealer repo rates remained more attractive, in our opinion.

Consistent with the increase in assets of prime MMFs across the industry, BlackRock prime funds experienced net inflows during the first quarter.

We believe investors exhibited demand for prime funds to take advantage of the incremental yield and diversification. At quarter-end, the spread between institutional government and prime MMF yields was 0.17%.⁶

Tier 1 Commercial Paper (CP) outstandings decreased by $47.4 billion over the quarter to $396.4 billion. As expected, CP rates continued to reprice in line with expectations for the future path of monetary policy. Financial CP within our prime funds maturing in three months or less ended the quarter with an average yield of 5.23%.

Rates on money market deposit instruments remained relatively consistent throughout the quarter, as overnight rates averaged 5.31% and 1-week also averaged 5.31%.⁷ Our prime funds favored these investments. Purchases during the period were primarily of certificate of deposits and time deposits, CP and overnight repo for eligible portfolios.

Although we favored a shorter-duration stance over the last several months to protect against interest rate risk, we have been more focused on adding exposures to highly rated longer tenor fixed positions to add duration where appropriate. At quarter end, our target WAM range was 45 to 50 days, and the prime funds had an average weekly liquidity of approximately 51%.⁸

In the first quarter, tax- exempt money funds saw slight net outflows, ending with approximately $121 billion in industry assets. Dealer variable rate demand note (VRDN) inventory ended the period at $5.1 billion, above the rolling 12-month average of $4.8 billion. VRDN new issuance remained light as the municipal yield curve remained inverted out to 18 years.⁹ The Securities Industry and Financial Markets Association (SIFMA) Index, which represents the average yield on 7-day municipal floating- rate debt, began the first quarter of 2024 at 3.87% then fluctuated between 1.90% and 4.55%, and reset to 3.64% at quarter-end.

Within the fixed-rate space, 1-year municipal bond yields and 1-year municipal note yields increased over the quarter from 2.67% and 3.12% to 3.24% and 3.32%, respectively.¹⁰

Other than interim financing needs by municipalities, municipal note issuance continues to remain seasonally light in the near term as issuers continue to work through their 2025 fiscal budgeting process and assess their upcoming financing needs.

MuniCash was positioned in the 6- to 8-day WAM range with high levels of daily and weekly liquidity.

Looking ahead, April is historically highlighted by tax-time and seasonal cash outflows, allowing dealers to reset VRDN yields higher to attractive levels and rewarding investors holding VRDNs at this time.

Consistent with the theme across the ultra-short bond industry, the BlackRock Short Obligations Fund experienced slight net outflows throughout the first quarter.

Tier 1 CP outstandings decreased by $47.4 billion to $396.4 billion during the quarter. Tier 2 CP outstandings increased by $9.6 billion to $114.8 billion at the end of March.¹¹

Yields in the Investment Grade (IG) space were volatile throughout the quarter, with the yields on the JULI All Ex EM 1-3 year index ranging between 4.91% and 5.35%.

January and February saw record IG issuance and issuance remained robust in March. Issuers in the utility and financial space pulled issuance forward as investors met the supply with ample demand to keep spreads contained. IG spreads tightened, and yields moved higher, driven by repricing of Fed cut expectations and significant new issue supply. Financial spreads outperformed non-financials over the end of the quarter.

Throughout the quarter, our focus was keeping the fund well positioned by focusing purchases on CP maturing between 1-week and 2-months at yields ranging from 5.47% to 5.58%. Other investments consisted of selective purchases of 2-to-3-year corporate bonds at yields ranging from 5.19% to 6.13% and 6- to 12-month CP at an average yield of 5.40% yield.¹²

We largely believe that the Fed has reached the endpoint of their aggressive hiking cycle; therefore, we look to maintain a neutral to long duration bias to lock-in income via longer rates and IG securities where attractive valuations present themselves.