Quarterly Portfolio Manager Commentary

December 31, 2022


First American Money Market Funds

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

Economic Activity – U.S. economic growth slowed throughout the fourth quarter (Q4) amid high inflation and rising interest rates due to aggressive Federal Reserve (Fed) tightening. The slowdown was most prevalent within interest rate sensitive sectors, including housing and manufacturing, while tight labor market conditions and strong wage growth supported resilient consumer demand. Following strong 3.2% growth in the third quarter, U.S. Gross Domestic Product (GDP) growth is projected to have slowed to near 1.5% to 2.5% during Q4. U.S. consumers continue to feel the effects of high inflation and tightening financial conditions as personal spending and retail sales weakened throughout the quarter, but easing inflationary pressures led to an improvement in real personal income. Early indications suggest labor market tightness has peaked, but employment conditions remain quite firm, with November U.S. job openings standing at 10.5 million open positions versus total unemployed workers in the labor force of 5.7 million. Monthly Non-farm Payroll (NFP) gains slowed in the quarter but still averaged 247,000 jobs per month, and the U3 Unemployment Rate fell to 3.5% in December. Average Hourly Earnings remains elevated at 4.6% year-over-year (YoY), further emphasizing strong labor demand. Inflation appears to have peaked as overall inflation pressures eased throughout the quarter. The headline Consumer Price Index (CPI) declined to 7.1% in November with CPI ex. food and energy rising 6.0% YoY. The Fed’s preferred inflation index – the PCE Core Deflator Index – increased 4.7% YoY for November. Commodity prices have largely reversed the sharp increase seen earlier in the year and demand for goods has subsided, but core services price inflation rose during Q4, owing to accelerating shelter costs and wage gains. Sticky services prices are expected to keep inflation elevated during 2023 as the Fed attempts to further slow demand through tighter monetary policy.

Monetary Policy – The Fed maintained its aggressive monetary policy stance throughout the quarter, raising rates by 75 basis points (bps) at the November 2 meeting and 50 bps at the December 14 meeting. The target range for the federal funds rate is 4.25% to 4.50%, an increase of 425 bps during the year. The Fed also continued to implement its balance sheet reduction program (quantitative tightening), with a monthly cap of $60 billion in Treasury securities and $35 billion of agency mortgage-backed securities. Following the December meeting, the Federal Open Market Committee (FOMC) released its updated Summary of Economic Projections, which indicated expectations for lower real GDP growth in 2023 and 2024 compared to projections from September, as well as modestly higher unemployment and inflation over the next two years. Additionally, the Fed signaled further rate hikes will be warranted, with the current FOMC median projection for the federal funds rate at the end of 2023 to be in the range of 5.00% to 5.25%. The Fed anticipates maintaining restrictive rate policies through 2023 to loosen labor market conditions and bring inflation down toward its 2% target.

Fiscal Policy – After two years of elevated fiscal stimulus, government spending was a drag on U.S. GDP in 2022. The government’s contribution to growth is set to rebound in the coming year, however, following the passage of a $1.7 trillion spending bill that includes a 6% increase in domestic spending initiatives and a 10% increase in defense programs. Additionally, social security and disability benefits are set to rise by nearly 9% in 2023. Nevertheless, the results of the midterm elections suggest political gridlock will be the theme in Congress over the next two years and no major fiscal packages are expected during President Biden’s remaining term in office. On the municipal side, state and local governments have seen early signs of tax collections starting to slow, but strong reserves have left them in a solid position if economic conditions weaken further.

Credit Markets – Absolute fixed income returns turned positive in the fourth quarter as longer-term yields stabilized on market expectations for a slower pace to future rate hikes and an eventual pivot to late 2023 rate cuts. While the quarterly point-to-point change in yield curve levels was relatively minor, intraday and weekly interest rate volatility remained elevated. Market technical factors continue to suppress front-end T-bill yields versus repo, money market funds and other very short-term investment options.

Yield Curve Shift

U.S. Treasury Curve

Yield Curve


Yield Curve




3 Month




1 Year




2 Year




3 Year




5 Year




10 Year




The rapid increase of Treasury yield curve levels through the first three quarters of the year abated in the fourth quarter. The decline in three to five-year yields was a positive performance differentiator for portfolios with exposure to the sector. The three-month to 10-year portion of the yield curve inverted by 46.8 bps after three-month T-bill yields jumped on 125 bps of Fed rate hikes in the quarter. At the same time, the two-year to 10-year portion of the yield curve inverted a further 10.1 bps to 55.1 bps.   

Duration Relative Performance

*Duration estimate is as of 12/31/2022

With stabilization in yield curve levels beyond two years, absolute returns turned positive and performance dispersion for indices with maturities less than three years was muted. Indices with exposure to securities maturing in three- to five-years outperformed their shorter duration counterparts, driven by an additional 23.5 bps of inversion in the two-year to five-year portion of the yield curve. 

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.

A-rated and BBB-rated corporate credit spreads tightened in the quarter, while their higher rated counterparts widened on the margin. Lower-rated issuers entered the quarter with more favorable credit spread valuations versus AA-AAA corporate credit and agency securities and benefitted from improvement in financial conditions during the quarter. 

Credit Sector Relative Performance of ICE BofA Indexes

ICE BofA Index

*AAA-A Corporate index outperformed the Treasury index by 38.3 bps in the quarter.

*AAA-A Corporate index underperformed the BBB Corporate index by 45.5 bps in the quarter.

U.S. Financials outperformed U.S. Non-Financials by 22.4 bps in the quarter.

Credit had a strong month versus agencies and treasuries. Down in credit outperformed higher-rated counterparts on spread compression and higher coupon income.

Higher U.S. Treasury yield curve levels were the driver of negative absolute returns for fixed income indexes. Stable credit spreads helped corporate debt to outperform comparable duration treasuries due to the higher coupon income levels of spread product. This is particularly evident in the 47.7 bps outperformance of BBB corporate debt versus treasuries.

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

The fourth quarter of 2022 continued with a similar theme as domestic and global inflation remained elevated and Fed rate policy commanded the attention of asset managers. Supply chain issues appeared to ease, but geopolitical events kept markets on edge. Even with GDP slowing and the odds of a recession increasing, policy makers signaled their committed to the inflation fight though markets appeared to question their conviction.   

Money market fund assets remained elevated while the Fed removed accommodation. With the Fed fully focused on price stability and the market anticipating additional rate hikes, money market funds remained an attractive investment option for fixed income investors.   

First American Prime Obligations Funds

Credit spreads in the money market have tightened modestly, reflecting market attitudes around moderating Fed tightening expectations. However, the trading ranges appear stable given the current rate and geopolitical environment. Considering the steepening front-end yield curve and a conservative cash flow approach, the Funds were positioned with strong portfolio liquidity metrics influenced by Fund shareholder makeup. We continued to employ a heightened credit outlook, maintaining positions presenting minimal credit risk to the Fund’s investors. Under the current market conditions, our main investment objective was to maintain liquidity while opportunistically enhancing portfolio yield based on our economic, credit and interest rate outlook, along with considerations of investor cash flow. We believe the credit environment and higher relative fund yields make the sector an appropriate short-term option for investors.

First American Government and Treasury Funds

Treasury bill/note and GSE supply remained tight as the Fed’s bloated balance sheet is limiting supply in all government related products. Even with the combination of the Fed’s tightening cycle and the steep front-end of the yield curve, historical quantitative easing has suppressed yields and extension opportunities, often pushing market yields below breakeven or economic equilibrium. To the benefit of the Government Obligations Fund, some value emerged in the GSE space as issuer funding needs increased and limited dealer take downs allowed the Fund to execute term purchases.  When presented with appropriate value, we purchased floating-rate investments that 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

Investors plowed an astonishing $12 billion into tax exempt money market funds over the first five weeks of the quarter – a roughly 12% increase in industry-wide AUM. This demand overwhelmed the supply of short-term securities and was the dominant factor impacting yields. The Securities Industry and Financial Markets Association (SIFMA), a gauge for seven-day variable rate demand notes, fell as low as 1.85%, and daily Variable Rate Demand Notes (VRDNs) had no problem clearing at levels more than 100 bps lower for close to two weeks. The low relative yields eventually encouraged a reversal in flows. These redemptions, combined with broker/dealer unwillingness to carry inventory, led to a massive spike in rates of nearly 200 bps in the final weeks of 2022. Amid the volatility, the Fund’s performance results were mixed. Allocations to fixed-rate commercial paper and notes benefited the overall yield for the majority of the period, but also detracted some in late December.                           

What near-term considerations will affect fund management?

In the coming quarters, we anticipate yields to rise modestly as the Fed winds down the initial phase of its inflation fighting campaign. We anticipate yields on non-government securities rising in step with forecasted and realized fed funds rate increases. Industry wide, Prime fund yields should increase as managers roll maturities into higher yielding securities and floaters reset in step with rate increase. 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 hawkish, we expect the investment environment for government money market funds to remain attractive to investors. As with the non-government debt, in the coming quarters, government yields should increase steadily as the Fed raises rates and quantitative tightening adds supply. 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. We will seek value in all asset classes and indexes, incorporating all domestic and global economic market data.

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