Staying Short or Time to Extend? By David Farris Strong employment numbers and sticky inflation readings have combined to prompt the Fed to indicate the potential for two more Fed Funds hikes this year even though many market participants anticipate a recession within the next year.  January 2024 Fed Funds futures, which at it’s low in March of this year was at 3.69%, is now at 5.298%.  In addition, the US Treasury is in the midst of issuing over $1 trillion of bills over the next few months.  Also looming later this summer is the issuance of new notes and bonds totaling over $1 trillion in 2023 with the possibility of that issuance nearly doubling next year.  The increased treasury issuance is needed to replenish cash in the wake of the debt-limit standoff and to fund a widening deficit, all putting further upward pressure on interest rates.   The question for those with money to invest is whether to extend durations now with interest rates approaching cycle highs or keep durations shorter in anticipation of a higher for longer scenario.  One strategy to consider offers doing both.   The following analysis shows investing in a fixed-rate MBS GNMA 30yr 5.50% combined with a monthly reset FNMA floating rate DUS.  The three Bloomberg screens below reflect the yield table and price profile for the fixed rate MBS as well as the yield table for the floater.  The floater has the price profile of a 1-month security since it reprices every month with no caps.   The combined result of investing $1mm in each of these two investments is noted below.  Line 11 illustrates the combined position loses of 2.74% in the +100 scenario.  That is the price risk of a 3-year Treasury note.  If an investor buys a 3-year Treasury though, the yield would stay the same, whereas the yield on this combined position actually increases from 5.68% at base to 6.19% in the +100 scenario (Line 14).  If rates fall 100 bps, the position has a gain of 1.60% (Line 11), almost the equivalent of a 2-year Treasury.  Not only is there a gain in the -100 scenario, but the yield down 100 basis points is still where Fed Funds (EBA) is today at 5.15%.  However, if the investor stayed in FF and rates went down 100, that yield goes down to 4.15% and there is no gain.   To summarize, this combined position has the risk profile of a 2.5-year treasury with a 5.68% current yield, around 50 bps more than what Fed Funds/EBA is currently paying.  Something worth considering when market forces are pulling in opposite directions. For more information, please contact your Country Club Bank Capital Markets Group Sales Representative. David Farris Asset Management Group, Inc. and Capital Markets Group 816-859-7527

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