Fidelity: Money Market Reform Transition Went Well

Emory Zink: I'm Emory Zink from Morningstar's Fixed Income Manager Research team. Today I am here with Rob Galusza from Fidelity's Limited Term Bond team.

Hello, Rob.

Rob Galusza: Good morning.

Zink: Welcome, thank you for joining us.

Galusza: Thank you.

Zink: So today I wanted to talk a little bit about what's going on in the limited term space. Wanted to kick it off by asking, there was money market reform that was implemented in October 2016. I know that the shorter duration markets were sort of expecting that in the years leading up to it, but how did that really change the landscape and sort of post-October 2016 have any of those changes persisted?

Galusza: You are correct, it was a big event that occurred last year. There was a transition of over $1 trillion out of prime money market funds into government money market funds. So as that transition occurred, there was a large movement of money that transitioned from one investment strategy into the government money market. So, for a time period, last summer and into the fall there was a little bit of dislocation that occurred into those markets with commercial paper, spreads moving higher. The LIBOR rates or interbank offering rates moving higher. So, that created some opportunities for the ultrashort and short-term bond space to come in and invest in those markets, both on the municipal money market side as well as the taxable money market side. So, surprisingly, with such a large amount of money that moved, the transition went relatively well. There was pressure at the front end of the curve, and now that we've been through that process things have normalized a bit, but there is still pressure at the front end of the market.

Zink: Interesting. Well, in addition to that piece, the Federal Reserve decided they were going to raise rates, but in 2016 they waited until December. So, what are your team's views on the rise in interest rates, the pacing of it, and how might it affect the positioning in your portfolios?

Galusza: Right. So, we do think we're in a tightening cycle here. We're in a rising interest-rate environment, and the question is how much and how fast. So, there are various views on how quickly the Fed will move. There is a new administration that's in place with some ideas of policy changes that are very, that are potentially pro-growth and so the Federal Reserve needs to consider those actions in their views. So, their guidance, they have given guidance of up to three potential tightenings this year. I would say we are more in line with the market and that we see potentially two tightenings in 2017. We think they are going to be more toward the back part of the year, potentially June and December as the market and the Fed has to digest what the new initiatives are going to be with the administration. So, what are the new fiscal stimulus policies going to be, what's going to be the impact with tax cuts? Does that create inflationary pressures on wages and some other key metrics that they are going to look at.

Zink: So, with these views on Federal Reserve policy, how would this affect the positioning in your portfolios?

Galusza: So, as we view, we will be in a rising rate environment this year. A couple of things, we have looked at within our short duration portfolios leaning a little bit on the short side of our target benchmark durations, as well as being overweight the spread sector. So, we are constructive on the economy at this point and we do like corporates as a sector. So, we have been overweight corporate bonds and some of the other spread sectors. And they tend not to trade with the same duration as the rates market and government market. So, that will allow our portfolios to empirically perform a little bit on the shorter side of the benchmark. So, we see that positioning being beneficial for shareholders in a rising rate environment.

Zink: That's very helpful. Thank you, Rob.

Galusza: Thank you.