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Investment strategies: More rate hikes predicted, current investment opportunities

For more perspective on the latest economic data, watch our Third Quarter Economic Update Webinar on demand.

Q3 Economic Update Webinar
Length: 30 minutes

By Jeff Duesler, Senior Investment Services Representative

While much of what was said by the Federal Open Market Committee (FOMC) on September 22 was expected, there was one notable exception: the dot plot forecast. You’ll recall that after the FOMC meets, they release a statistical analysis called a “dot plot,” and FOMC participants are invited to make or plot their predictions for an appropriate Fed funds rate at the end of the year; each prediction is represented by a literal dot. In September’s meeting, nine out of 18 committee members are now expecting one or two rate hikes in 2022. This is a significant change from the last quarter – in June’s FOMC meeting, no members were predicting rate hikes for 2022; they were predicting two rate hikes by the end of 2023.

The Fed will continue to weigh all the variables in the economy, such as job growth and inflation; if it looks like the economy is improving or inflation runs higher and faster than the FOMC’s target, the Fed will be more likely to raise interest rates faster. For more perspective on the latest economic data, including job growth, watch the webinar on demand.

Current investment opportunities

While not much has changed as a result of this meeting (other than the dot plot forecast), now is a good time to review the types of investment opportunities out there for credit unions in this low-rate environment.

SimpliCD Issuance

Corporate One has noticed a slight uptick in SimpliCD issuance with some issuers rolling over or refinancing issues that are maturing at a slightly higher pace. Issuers are being strategic, as well, issuing out over longer periods of time. For example, if someone had a three-year CD maturing, issuers were offering rollovers in five-year terms. I think this trend was even more prevalent prior to the emergence of the recent increase in COVID cases.

Lending vs. deposit growth

Overall, it appears that lending continues to pick up at credit unions; however, based on what we’re hearing from credit unions, lending is outpacing deposit growth at the same pace. If this holds, what that means is liquidity will once again come into play, and we may see more issuance of non-member deposits from credit unions and an increase in demand of wholesale deposits from banking institutions.

Securities

The value in the market continues to be in securities, and there is a benefit for choosing a longer term because of the steepness in the yield curve. An example of this is the spread between two-year and five- year U.S. Treasuries. In this case, rates are moving up faster in the five-year area of the yield curve than the two-year area. Being armed with this information, it may make sense to look at longer-term options if your credit union’s balance sheet allows. Although we have seen credit unions doing this, we also see some hesitation and a preference to stay within a two-year time frame, as there is still an uncertainty with a certain percentage of cash that is in credit union members’ accounts and how long it stays at the credit union. However, with the funds that are ear-marked for investments, it might make sense to extend out the yield curve and maybe set that longest rung on the ladder to five years. Or maybe use the “barbell approach” that we have spoken about in the past, staying in cash and investing slightly longer term.

As far as security selection, value continues to be found in the following options:

  • Amortizing securities like mortgage-backed securities where you can pick up yield to government agencies and U.S. treasuries. At the same time, principal amortizes so that can be reinvested.
  • Floating rate securities in the form of SBA Pools or Freddie MAC K securities. Freddie Ks have 7-10-year final maturities and float to the avg 30-day SOFR rate. These are pools of commercial loans, consisting mostly of multi-family properties that are guaranteed by Freddie Mac. The borrowers are limited by costly prepayment penalties. The SBA offers floating rate pools that are tied to SBA loans to small businesses and guaranteed by the SBA.
  • U.S. Treasuries over bullet agencies, and for many credit unions, Certificates of Deposit. Much like before, bullet agency spreads/yields are either the same as U.S. Treasuries or, in some cases, lower! U.S. Treasuries are zero-risk weighted and are at the top of the food chain as far as liquidity is concerned, meaning that some rates on Treasuries are higher than CDs for some credit unions.
  • Callable agencies might be worth considering (if you expect rates to move up). Volatility is lower, and when volatility is lower, the likelihood of a bond being called is also lower. During this time, while the additional yield the issuer pays to issue the call is also lower, there is still additional yield. This means that callable securities have a spread over treasuries and agency bullets but are less likely to be called; so, you could buy a new issue at par or a secondary callable bond at a discount and pick up yield to CDs, bullet agencies, and U.S. Treasuries.

Final takeaways

In summary, at Corporate One we continue to suggest laddering your credit union’s investment portfolio and shaping it to complement the balance sheet. If you are a CD buyer, it’s still a good time to take advantage of new names if and when they become available. Consider going out longer to take advantage of the shape of the yield curve. Look toward securities that amortize like mortgage-backed securities to have principal and interest coming back monthly that can be redeployed. And finally, callable bonds at par or lower offer an opportunity to pick up “some free yield” from the issuer because of the call that might not get used.

I encourage you to speak with your senior investment services representative individually or our investment department at 800/366-2677 for specific offerings and availability of these and other opportunities.