Quarterly Portfolio Manager Commentary

January 2022

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First American Money Market Funds

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

Market movements were influenced by rising inflation levels and expectations the Federal Reserve (Fed) will more aggressively remove monetary policy accommodation. These factors pushed yield curve levels higher, resulting in negative performance for most fixed income indexes.

Economic Activity – U.S. Gross Domestic Product (GDP) rebounded in the fourth quarter (Q4), with growth estimates in the 6.0% range after the third quarter’s 2.3% pace. Consumer spending continues to outstrip supply and production capacity, aggravating inflation pressures. Employment conditions remain historically tight, with November U.S. Job Openings standing at 10.439 million open positions vs. December’s Total Unemployed Workers in the Labor Force of 6.319 million. Further emphasizing strong labor demand, the U3 Unemployment rate fell to 3.9% in December and Average Hourly Earnings rose a healthy 4.7% in 2021. Recent Non-farm Payrolls (NFP) readings have diverged from other employment indicators, adding 199,000 jobs in December and 1.096 million in the quarter vs. Household Survey gains of 651,000 and 2.169 million, respectively. NFP are down 3.572 million jobs since February 2020, despite a full recovery of GDP to pre-COVID levels and low unemployment rates. The headline Consumer Price Index (CPI) was 7.0% for 2021, with CPI ex. food and energy rising 5.5% year-over-year (YoY). The Fed’s preferred inflation index – the PCE Core Deflator Index – increased 4.7% YoY through November, the highest reading since 1989. Given the persistence of supply chain issues and wage and price pressures, the Fed has stopped describing inflation trends as transitory.

Monetary Policy – The Fed accelerated the wind down of asset purchases at the December 15th meeting, doubling the tapering pace to $30 billion per month and targeting March for completion. The minutes from the December 15th meeting suggested Fed officials believe the dual goals of average inflation of 2% and maximum employment have been achieved, clearing the way for a potential rate hike as early as the March 16th meeting. The current Fed Dot Plot predicts three rate hikes in 2022 followed by three more in 2023. Fed funds futures predict a similar path for policy rates. Usage of the Federal Reserve New York’s Reverse Repo Program reached a record high of $1.904 trillion at year-end and averaged $1.494 trillion during the quarter, a clear sign of excess liquidity in the financial system as Fed asset purchases are simply being recycled back onto the Fed’s balance sheet. Given the excess cash in the system, policymakers have signaled balance sheet reduction – quantitative tightening – will occur at some point in 2022.

Fiscal Policy – President Biden’s “Build Back Better” plan stalled in Congress, but the Administration was able to pass a $1.2 trillion infrastructure bill in November. While passing further COVID-related stimulus is unlikely, government spending is still expected to grow 1.4% in 2022 and continue contributing to GDP growth. Importantly for financial markets, the Federal debt ceiling limit was raised by $2.5 trillion in December, which is enough borrowing capacity to potentially fund U.S. Treasury borrowing into early 2023. 

Credit Markets – Higher inflation numbers and growing expectations for Fed rate hikes pushed U.S. Treasury yields higher. Credit markets continued to experience strong primary and secondary market liquidity and high investor demand for yield. Very short deposit, money market fund and T-Bill yields remained near zero, where they are likely to remain until the first Fed 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




Yield curve levels rose meaningfully in the quarter on surging inflation data and growing expectations for multiple Fed rate hikes in 2022. Given their maturity horizon, two- and three-year yields were most impacted by the increased probability of rate hikes. Ten-year yields, which are more influenced by inflation expectations than Fed policy, barely budged in the quarter, suggesting markets expect inflation levels to ease over the longer run.

The three-month to ten-year portion of the yield curve steepened a mere 2.6 basis points (bps) to 148 bps. Three-month yields should move higher as the T-Bill issuance rises in Q1 2022 and Fed rate hikes begin to get priced into the T-Bills rolling three-month horizon. We expect this portion of the curve to flatten as short yields jump on more frequent Fed rate hikes with longer rates rising to a lesser degree as inflation levels rollover later in 2022.

Duration Relative Performance

*Duration estimate is as of 12/31/2021

ICE BofA Treasury Index

Q4 2021 U.S. Treasury performance played out as expected, with longer duration strategies more adversely impacted by rising rates. Negative Treasury performance was exacerbated by the low coupon levels of the indexes, which offered minimal income protection against declining bond prices.


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




*OAS = Option-Adjusted Spread

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 Asset-Backed Security (ABS) credit spreads widened in the quarter, driven by shrinking year-end dealer balance sheets, expectations for reduced central bank support, rising yield curve levels and concerns over surging COVID infection rates. Demand for credit remains strong, bolstered by the generally solid economic outlook and higher all-in corporate yields. Outperformance in the agency space versus U.S. Treasuries was probably impacted by concerns over the Federal debt ceiling in the quarter. Negative agency spreads are unsustainable and reduce the attractiveness of the sector.

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.

Given the significant moves in both yield curve and credit spread levels, the relative performance parity among various sectors was surprising. The uniformity of returns was partially due to the indices’ low coupon and credit spread levels, implying the positive effect of coupon income was swamped by rising yield curve levels, particularly in the two- and three-year portion of the curve.

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

The Q4 economic outlook continued with a choppy but still positive tone with decent economic data and general market optimism even in the face of another COVID variant entering the fray. However, front-end yields remained challenged as technical forces pushed additional cash into the system coupled with the FOMC’s stimulative monetary policy. The money market industry remained flush with deposits while front-end U.S. Treasury bill and Repo levels remained entrenched at the bottom of the FOMC’s fed funds target range. However, a more hawkish tone from the Fed led to a steeping of the yield curve and a brighter outlook for yields in the upcoming quarters.

First American Prime Obligations Funds

Credit spreads remain tight, reflecting the trading ranges and yields one should expect in the current rate environment. Considering a flat to modestly rising yield curve and a conservative approach to cash flows, 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 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 and government funds continued to see modest inflows as monetary system cash balances continued to grow. Treasury Bill / note and Government-Sponsored Enterprise (GSE) supply continued to be tight due to the U.S. Treasury general account reduction and the Fed's stimulative monetary policy. The debt ceiling resolution was resolved too late to have a meaningful Q4 impact. The flat yield curve presented limited extension opportunity resulting in shorter fund metrics. However, as we began to hear a more hawkish tone from the Fed, some steepening to the yield curve and reasonable longer-term investment opportunities appeared. We also capitalized on opportunities in floating-rate investments throughout the quarter that made economic sense and felt would benefit shareholders over the securities holding period. We anticipate that investment strategy will be more fluid in the coming quarters as markets make determinations on the Fed’s pace and course of tightening.

First American Retail Tax Free Obligations Fund

Market conditions for tax exempt money market funds have been stable. The overall level of assets in the space was steady in recent months at just less than $90 billion. While this remains well below pre-pandemic levels, flows into longer muni bond funds have been positive – and may be providing some support to front-end yields. Municipal note issuance continues to be quite limited. While Q4 is not typically an active period for note issuance, it was nonetheless bleak. Only about a dozen significant tax-exempt issues ($50 million+ deal size) came to market – punctuating a year that saw short-term financings fall by approximately 40%. Other than a bit of a spike higher in variable rate demand notes toward year-end, most municipal money market investments saw yields fluctuate by only a handful of bps. This is striking in the face of rising Fed rate hike expectations which have driven 12-month Treasury bills approximately 30 bps higher.

What near-term considerations will affect fund management?

In the coming quarters, we anticipate yields will rise as the Fed begins lift-off from its extraordinary accommodative monetary policies. We will anticipate yields on non-government debt to follow suit providing more attractive investment option across the curve. In the coming quarters, prime yields should increase steadily as supply increases and the yield curve steepens. We will capitalize on investment opportunities that make economic sense based on our market outlook and break-even 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 turning more hawkish and debt ceiling resolved for the next year, we expect the investment environment for government money market funds to improve. As with the non-government debt, government yields should increase steadily in the coming quarters as the Fed finishes tapering and begins rate lift-off. 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. Management will capitalize on investment opportunities that make economic sense based on our market outlook and breakeven analysis. We will seek value in all asset classes and indexes, incorporating all domestic and global economic market data.

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