Quarterly Portfolio Manager Commentary

April 2022


First American Money Market Funds

What market conditions had a direct impact on the bond market this quarter?

Yield curve levels soared on higher inflation data, a 25 basis point (bps) Federal Reserve (Fed) rate hike and an increase in market expectations for more aggressive Fed tightening. The war in Ukraine and general market volatility pushed credit spreads wider in the quarter. The combination of higher yields and wider spreads resulted in deeply negative performance for most fixed income indices.

Economic Activity – U.S. economic conditions weakened throughout the quarter, highlighted by slowing global growth and surging inflation pressures owing to rising commodity prices. U.S. Gross Domestic Product (GDP) slowed in the first quarter (Q1), with growth estimates in the 1.5% range following the fourth quarter’s strong 6.9% pace which benefited from a large inventory build-up. The headline Consumer Price Index (CPI) rose to 7.9% in February, with CPI ex. food and energy rising 6.4% year-over-year (YoY). The Fed’s preferred inflation index – the PCE Core Deflator Index – increased 5.4% YoY for February, the highest reading since 1983. Inflation levels are projected to peak over the next couple of months, but given persistent supply chain issues and wage and price pressures, we expect them to remain elevated into next year. Consumer spending continues to outstrip supply and production capacity, further aggravating inflation pressures. U.S. consumers remained resilient throughout the quarter despite higher inflation and reduced purchasing power. Employment conditions remain tight, with February U.S. Job Openings standing at 11.266 million open positions vs. March’s Total Unemployed Workers in the Labor Force of 5.952 million. Further emphasizing strong labor demand, the U3 Unemployment rate fell to 3.6% in March and Average Hourly Earnings rose a healthy 5.6% YoY. Non-farm Payrolls (NFP) readings continued the strong pace of 2021, averaging 560,000 jobs per month during Q1. Despite broad-based labor market strength throughout the quarter, historically tight conditions are constraining economic growth and driving prices higher.

Monetary Policy – The Fed lifted rates 25 bps at the March 16th meeting and indicated through their Dot Plot expectations for an additional 150 bps of tightening in 2022. Surging inflation numbers have increased both market expectations and Fed rhetoric for a more aggressive pace to rate hikes, with 50 bps increases at the May 3rd and June 15th meetings becoming the market’s base case. Further, the March 16th meeting minutes revealed plans to begin balance sheet reduction at a $95 billion ($60 billion in U.S. Treasuries and $35 billion in agency mortgage-backed securities) monthly pace, likely starting in May.

Fiscal Policy – After two years of unprecedented fiscal stimulus to counter the negative economic impact of COVID-19, government spending will likely be a drag on U.S. GDP in 2022. State and local governments are, for the most part, in excellent shape, flush with surging tax collections and still unspent federal pandemic relief funding. Given current inflation pressures and the difficulty in passing legislation during the 2022 election cycle, the probability of further fiscal stimulus measures is low. 

Credit Markets – Spiraling inflation numbers, lift-off to Fed rate hikes with expectations for an accelerated pace going forward sent U.S. Treasury yields soaring in the quarter. As a result, fixed income performance was deeply negative in the quarter. Demand for new-issue debt remained strong, although market volatility has begun to expose some cracks in overall market liquidity, reflected mainly in wider bid-ask spreads. Money market fund, T-Bill and agency discount note yields have lifted off the zero barrier post-March 16th rate hike.

Yield Curve Shift

U.S. Treasury Curve

Yield Curve


Yield Curve




3 Month




1 Year




2 Year




3 Year




5 Year




10 Year




Treasury yield curve levels surged as markets accelerated the pace and magnitude of Fed rate hikes with two- and three-year yields most impacted. The rise in 10-year yields was significant but less so than for shorter maturities, suggesting markets expect inflation levels to ease over the longer run.

The three-month to 10-year portion of the yield curve steepened a healthy 37.6 bps to 185.6 bps. At the same time, the two-year to 10-year portion of the yield curve flattened 77.4 bps, creating an essentially flat, to sometimes inverted, yield curve. The diversion between the two portions of the curve implies 1) significant Fed rate hikes are priced into two-year yields, and 2) recession risks, as reflected in the shape of the yield curve, are rising.

Duration Relative Performance

*Duration estimate is as of 3/31/2022

ICE BofA Treasury Index

Q1 2022 U.S. Treasury performance played out as expected, with longer duration strategies more adversely impacted by rising rates. The ICE BofA 1-5 Year U.S. Treasury Index’s -3.162% Q1 return was the index’s worst quarterly performance in more than 40 years.


Credit Spread Changes

ICE BofA Index

OAS* (bps)


OAS* (bps)




1-3 Year U.S. Agency Index




1-3 Year AAA U.S. Corporate and Yankees




1-3 Year AA U.S. Corporate and Yankees




1-3 Year A U.S. Corporate and Yankees




1-3 Year BBB U.S. Corporate and Yankees




0-3 Year AAA U.S. Fixed-Rate ABS




*Option-Adjusted Spread (OAS) measures the spread of a fixed-income instrument against the risk-free rate of return. U.S. Treasury securities generally represent the risk-free rate.

Corporate and ABS credit spreads widened in the quarter, with most of the damage done in the first two months of the year. AAA-A spreads stabilized in the second half of March. The steep decline in BBB corporate spreads in March was primarily related to removing Russian-related bonds from the index at quarter-end.

Credit Sector Relative Performance of ICE BofA Indexes

ICE BofA Index

*AAA-A Corporate index underperformed the Treasury index by 2.3 bps in the quarter.

AAA-A Corporate index underperformed the BBB Corporate index by 5.0 bps in the quarter.

U.S. Financials underperformed U.S. Non-Financials by 7.9 bps in the quarter.

Not surprisingly, Q1 investment performance was abysmal across all asset classes, given the jump in yields and wider credit spreads. Credit sectors underperformed comparable duration Treasuries, although the differential vs. AAA-A rated credits was relatively minor. BBB credit significantly underperformed their higher-rated counterparts, partially due to the presence of several Russian-related issuers in the BBB benchmarks. These issuers tend to be industrials rather than banks, which account for the majority of the performance dispersion between the non-financial and financial indexes.

What were the major factors influencing money market funds this quarter?

The first quarter of 2022 brought plenty to the table as domestic inflation continued to surge and Russia invaded Ukraine, roiling global markets. While COVID-19 appears to be fading (at least for the time being) in the U.S., China’s zero COVID-19 policy is proving difficult to execute. The Fed is feeling the pressure of having lost the inflation narrative and the market has concluded that they are well behind in the inflation fight. The Fed raised the fed funds rate 25 bps at the March meeting and additional rate hikes are expected at each meeting for the remainder of the year. Balance sheet reduction is also expected to commence in the coming months. The money market industry is still flush with cash and the short-end curve is pricing in expected rate hikes. We expect continued upward pressure on rates for the remainder of the year as the Fed turns its focus to price stability.  

First American Prime Obligations Funds

Credit spreads in the money market have widened, reflecting the volatility around Fed expectations and exhibiting the trading ranges and yields one should expect in the current rate and geopolitical environment. Considering the steepening front-end yield curve and maintaining a conservative cash flow approach, the fund was positioned with strong portfolio liquidity metrics influenced by fund shareholder makeup. Management continued to employ a heightened credit outlook maintaining positions presenting minimal credit risk to the fund’s investors. Under the current market conditions, the main investment objective was to maintain liquidity and judiciously and opportunistically seek to enhance portfolio yield based on our economic, investor cash flow, credit and interest rate outlook. We believe the credit environment and relative fund yields make the sector an appropriate short-term option for investors.

First American Government and Treasury Funds

Treasury bill / note and Government-Sponsored Enterprise (GSE) supply remained tight as the Fed’s expansive balance sheet has limited supply in all government-related products. Even with the Fed in a tightening cycle and the short-end curve significantly steeper historical quantitative easing suppressed yields and extension opportunities with breakeven yields often below economic equilibrium. However, management exploited economical term purchases when the market presented them and captured yield across the curve. When presented with appropriate value, we also purchased floating-rate investments that made economic sense and could benefit shareholders over the securities holding period. We anticipate that investment strategy will be more fluid in the coming quarters as markets determine the Fed’s pace and course of tightening.  

First American Retail Tax Free Obligations Fund

We have noted previously how industry-wide, tax-exempt money market fund assets under management are insufficient to absorb the current level of variable rate demand notes (VRDN) outstanding. In fact, the deficit is now approaching $25 billion. Throughout much of the past two years, other buyers provided ample support such as municipal bond funds. However, these funds experienced massive reversals in cash flows during the recent quarter. This has led to increased VRDN put activity, rising broker-dealer inventories and ultimately higher resets for the SIFMA index. A good part of the move up in VRDN yields preceded the first hike from the Fed in March. The outflows from bond funds also impacted rates on municipal notes and other short bond maturities as secondary bid-wanted activity soared. Expectations for more aggressive Fed tightening was an additional contributor to the upward pressure on municipal yields. The fund added several fixed-rate positions during the period. Most of these new investments mature in June 2022 or shorter, which will help to mitigate the interest rate risk of an uncertain Fed policy outlook.  

What near-term considerations will affect fund management?

We anticipate yields will rise significantly in the coming quarters as the Fed ramps up its inflation-fighting campaign. We anticipate yields on non-government securities rising in step with expected and realized fed funds rate increases. Industry-wide, prime fund yields should increase steadily as managers invest maturing securities at higher rates. We will seek to capitalize on investment opportunities that make economic sense based on our market outlook and breakeven analysis. The institutional and retail prime obligations funds will remain reasonable short-term investment options for investors seeking higher yields on cash positions while assuming minimal credit risk.

Yields in the GSE and Treasury space will remain influenced by Fed policy and Treasury bill / note supply. With the Fed now hawkish, we expect the investment environment for government money market fund investors to improve significantly. As with the non-government debt, government yields should increase steadily in the coming quarters as the Fed begins quantitative tightening and aggressively raises rates. Any large supply changes in Treasury issuance may create some yield volatility on the front end as the forces of supply and demand seek optimization. Based on our market outlook breakeven analysis, management will seek to capitalize on investment opportunities that make economic sense. We will seek value in all asset classes and indexes, incorporating domestic and global economic market data.

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