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Investment Strategies: Positioning your credit union’s portfolio after rate cuts

By Jeff Duesler, Senior Investments Services Representative

As many anticipated, the Federal Open Market Committee (FOMC) announced a 25-basis-point rate cut at their September meeting. The FOMC also cut the rate on interest on excess reserves (IOER) 30 basis points to 1.80%. This marks the second rate cut this year. Today’s article will briefly review some of the details about the Fed’s decision and future market predictions, as well as how your credit union can position your investment portfolio despite rate expectations.

Seven of the 10 FOMC members voted to lower the rate while three members dissented, one of which preferred to lower the target rate 50 basis points. Notable changes made to the FOMC’s statement in September were the following:

  • The removal of language stating the intention to reduce the balance sheet (reduction of aggregate securities holdings).
  • Maintaining their pledge to act as appropriate to sustain the economy’s expansion.
  • Noting the competing forces of the trade war with China and weak global growth versus the strength of the U.S. consumer side of the economy with this statement: “Although household spending has been rising at a strong pace, business fixed investments and exports have weakened.”

Some economic projections were also notable. The FOMC believes their inflation target of 2% won’t be reached until 2021, while the inflation projection for 2019 is 1.8%. This is a partial justification for lower interest rates despite a very low unemployment rate. You can read more about the FOMC’s economic projections on the Federal Reserve’s website.

The closest thing to a crystal ball: the “Dot Plot”

In a previous article, I reviewed how the statistical analysis released by the FOMC after their meeting, called a “dot plot,” works. FOMC participants are invited to make (plot) their predictions for an appropriate Fed funds rate at the end of the year, and each prediction is represented by a dot. Based on the dot plot following the September meeting, participants anticipate the September cut to be the last in 2019. The chart below displays what FOMC participants anticipate for the rest of the year and following.


However, the market itself is calling for a 77% chance of a cut in December with high probabilities of rate cuts throughout 2020, according to the Bloomberg World Interest Rate Probability (WIRP) page (shown below). The third column from the left called “Cut Prob” indicates the “cut probability” for December. (Note that this page changes with Fed Funds futures trading.)

The next FOMC meeting with a press conference (when rate decisions are usually made) is December 11. There is time between now and then for adjustments to be made to these expectations, and there certainly are some harbingers that could influence the economy. For example, a resolution to the trade dispute with China that would include an impactful trade deal would be a positive sign for the economy and cause a lower likelihood of a rate cut.

How to position your credit union’s portfolio

Though rates may (and will) go up and down, and the market regularly shifts back and forth from stable to volatile, investment professionals can still rely on the following strategies:

  • Having a defined process and sticking to that process is paramount. For example, you may decide that a three-year ladder approach works best for your credit union’s liquidity and income needs. We’ve discussed the laddered approach in the past, and it continues to be a tried and true process for income and liquidity needs. This process also insulates the portfolio from fluctuations in interest rates, investing in current, fresh rates every month, every week, or every quarter.
  • Overall interest rate risk should be viewed with a holistic approach from an overall balance-sheet perspective. This is similar to the laddered approach just mentioned, which involves looking at the balance sheet and positioning the investment portfolio in a way that compliments the balance sheet. Viewing each investment from a different lens is not prudent.
  • Security selection should be evaluated by risk-reward, and patient decision-making beats the “bond-of-the-day” approach. One of the ways quarterbacks are evaluated is by their ability to “see the whole field.” Investment professionals have access to “the whole field” when you have the ability to purchase multiple investment vehicles that fall within the regulatory framework. This allows you to be indifferent to the investment you add to the portfolio that fits your spot in the ladder.
    • To evaluate risk-reward, different tools can be used, such as Bloomberg screens and looking at things from a historical perspective. For example, if you are looking at a security that is spread over a U.S. Treasury (like a government agency bullet), and if that spread is wider than usual (the overall yield on a relative basis is higher), taking on the risk of the agency is appropriate in this case.

Since the overall trajectory of interest rates is currently lower, let’s briefly discuss investments that tend to perform better in a falling interest rate environment.

  • Bullet Agency Securities. Bullet agency securities are U.S. Government agency securities that have a fixed rate coupon and a stated maturity date, and they cannot be called prior to maturity. These securities tend to perform very well, especially in a normal interest rate environment (one with a positively sloping yield curve).
  • U.S. Treasury Securities. These securities are going to operate like bullet securities, but their yields are (usually) going to be lower based on being backed by full faith and credit of the U.S. government. One of the many benefits of investing in U.S. Treasury securities is the fact that there are many issues available (i.e. multiple maturity dates in multiple months to fit a ladder).
  • Certificates of Deposit. Bullet CDs operate the same way. The drawbacks to CDs are that they aren’t as liquid as the other security types and your investment is only insured up to $250,000 per institution (FDIC/ NCUA insurance number).
  • DUS (Delegated Underwriting Servicing) Bonds and other agency commercial mortgage-backed securities. DUS bonds offer investors the opportunity to look for stable cashflows and to extend the duration of the investment portfolio. These types of securities offer call protection in the form of yield maintenance that penalizes or prevents the borrower from prepaying the mortgage on their investment property. Many of these bonds act much like a bullet security, but investors can also benefit from amortization: the securities pay back principal prior to maturity.

Although we don’t know exactly what the FOMC might do in the coming months, anticipating lower rates is probably the safer bet. As the person involved in managing the investment portfolio for your credit union, it’s best to focus on the things you can control. Having a plan and a vision for shaping the portfolio, being agile like a quarterback who can “see the whole field,” and pivoting into different security types to minimize risk and maximize return, will be the best preparation for market fluctuations.

You can also take advantage of educational opportunities that are offered to you through Corporate One, and your senior investment representatives are always willing to have unbiased educational conversations. Feel free to reach out to our department anytime at 800/366-2677 or