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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.