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Investment strategies: Reviewing 2020 and looking forward to 2021

Quarterly Economic Update Webinar

Dig into this quarter’s economic data in more detail. Available now on-demand.

By Bob Post, Chief Investment Officer, and Jeff Duesler, Senior Investment Services Representative

If you're like most people, the New Year can’t come soon enough. There is no doubt that 2020 has been a challenging year for all of us. As we reflected on what our expectations were for 2020 when compiling last year’s review of 2019, we were reminded that this year certainly didn’t turn out as “uneventful” as we expected it to. For example, we didn’t expect the Federal Reserve to make any moves during 2020 as they intended to remain neutral during the election cycle. Of course, the pandemic situation altered those predictions substantially. In fact, the pandemic substantially altered or impacted almost everything in our economy this year. By way of review, here are a few highlights that happened.

In order to combat the economic fallout of forced shutdowns, the government and the Federal Reserve Bank announced several unprecedented steps:

  • Congress, along with the White House and Treasury, passed a massive stimulus bill designed to help American workers and their families, small business owners, and companies both large and small (like healthcare and hospitality) affected by the pandemic and the multiple shutdowns.
  • The Federal Reserve had a series of back-to-back interest rate cuts, including an emergency weekend meeting. These cuts resulted in the overnight rate moving to its current range of 0-.25% from 1.50% to 1.75%.
  • The Fed created emergency lending facilities designed to help state and local governments, as well as the airline industry, and also opened a main street lending facility designed for emergency lending to small businesses.
  • The Fed began purchasing U.S. treasuries and mortgage-backed securities, a process we are all too familiar with known as “quantitative easing.” This additional step, along with the lowering of the overnight rate, have been the Fed’s most effective tools to try and ease the economic burdens caused by the pandemic. The buying of these specific treasuries and securities has resulted in record-low mortgage rates, driving borrowers into refinancing loans at an extremely fast pace.

While government stimulus and Fed support provided support to the economy, the success and market prices of certain companies (mostly tech and healthcare) have outweighed the losses of others (traditional retail, travel, and hospitality), and equity markets continue to trade at record highs. Unfortunately, for those tethered to the fixed income markets, rates hit historic lows this year. The 10-year U.S. Treasury traded as low as .31% in March after climbing above 1.50% (pre-pandemic). Longer-term rates have moved up faster than shorter term rates (a yield curve steepening) since then, but with 2-year treasuries below .15%, it has become exceedingly difficult for those charged with investing excess liquidity.

High deposit growth, increased investment activity

According to Callahan & Associates, as of the close of the third quarter of 2020, credit union share balances grew 18.1% year over year. Cash and investment balances at the end of the third quarter were up around 40% since year end 2019. While most of these funds remained in cash or cash equivalents (nearly 40%), investments in securities and certificates of deposit increased 7% during the third quarter. A likely explanation for the large make-up of cash within the portfolio is a lack of precedent as to how share balances might respond to a fully opened economy, as well as low interest rates overall.

As credit unions adjust to this new world of low investment rates and rising cash balances, we expect them to deploy excess cash in investments that provide a greater return.

Looking ahead to the New Year

As we begin 2021, the economy will continue to feel the effects of the pandemic. Investors will keep a watchful eye on the effectiveness of vaccination distribution and the need, content, and execution of future monetary and fiscal stimulus. It remains to be seen how quickly the economy revives as we attempt to exterminate the virus globally through vaccination and herd immunity; these things will be watched very carefully by the forward-looking markets.

Interest rates are likely to stay low, compressed by monetary stimulus and the anticipation of job creation and inflation. The Federal Open Market Committee (FOMC) has stated that, depending on the circumstances, this summer it may allow inflation to run past its traditional target of 2%. And, speaking of the FOMC, the Fed updated its forecast in their meeting this month for real GDP to fall 2.4% in 2020 compared to 3.7% predicted in September. The Fed also expects real GDP growth of 4.2% for 2021. Most importantly, the FOMC stated in their meeting that they would continue to buy at least $120 billion of bonds each month and keep the target overnight rate between 0-.25%.

Regardless of any new programs created or the alteration/elimination of any existing monetary stimulus acts, expect the Federal Reserve to be a key cog in the economic recovery engine. As far as credit unions are concerned, we anticipate credit unions favoring investments other than CDs as the glut of liquidity in the banking sector continues, resulting in very little demand for outside or wholesale funding needs from both banks and credit unions. This makes it very difficult for investors to find value in this market. Presently, there are opportunities for investors whose balance sheets allow them to add some duration to their portfolios. For tips on positioning your credit union’s portfolio, review this article.

In conclusion, though 2020 was not the year we wanted or expected, our Investment and Funding teams are grateful for the opportunities we had to serve your credit union. We hope you have a peaceful and meaningful holiday season, and we are all looking forward to a new (and hopefully better) year with continued opportunities to serve you.