Yesterday the treasury market closed at these yields for the maturities listed:
5.55% One month
5.46% Three month
5.24% Six month
4,80% One Year
4.33% Two Year
3.95% Ten year
This inverted yield curve, where short term rates exceed long term, can be an ideal time for asset management.
This is because return and liquidity are both optimized by staying short. If an asset or investment manager is matching with specific liabilities, the prospect of a duration gap between asset and liabilities can be minimized.
This is a Goldilocks ALM environment where return and liquidity are both optimized. By going long now, an investment manager will have a lower return versus staying short. That might seem like a surefire market bet as Chairman Powell has forecast several rate reductions this year. That is until inflation possibly comes back, and further reductions put on hold.
The Credit Union Opportunity
An additional advantage, besides reducing ALM mismatches, is that it allows balance sheet management to remain agile. Shorter maturities provide more opportunities to respond to market and/or liability changes.
A prime example is NCUA’s management of the $22 billion NCUSIF investment portfolio. The fund continued its 7 year ladder as rates went to near zero in 2019-2021. When the market turned, the entire portfolio was underwater, burdened with an average duration of almost three years.
Through October 2023, the year-to-date return on the Fund is 1.92% and the portfolio reports a $1.7 billion unrealized loss.
When looking at historical trends, a yield on the NCUSIF portfolio of just 2.5% would result in a breakeven, that is stable, equity ratio in almost all years.
Recognizing this liability target for asset returns, makes NCUSIF investment decisions easy in this rate environment. By moving from overnight to maturities up to two years, the yields would be more than sufficient income to maintain the Fund’s equity ratio at or above 1.3% for any scenario.
Many investment managers were surprised by the Fed’s rate reversal to counter inflation. Today’s interest rates provides a rare moment for stabilizing both liquidity and return for credit union portfolios and the NCUSIF.