The Meek … Inherit a Prominent Place in Bond Portfolios There are a whole lot of anomalies in community banking in the waning stages of this restrictive Fed cycle. One of the overriding themes is the sheer duration of the process. We’re now fully one year past the last tightening, which has left the effective overnight rate at 5.375% since July 2023, and given rise to the “higher for longer” sound bite. The past six tightening cycles have averaged well under a year between the last hike and the first ease. We will be soon approaching another record: the longest-ever pause between the last hike and the first cut is 15 months, from June 2006 to September 2007. There are myriad implications on community bank operations from this year-plus hibernation. Being a representative of the broker-dealer industry, I’d like to point out the attractive yields available in most any investment sector that banks care about. Baked into this decadent batter, however, are three obstacles for portfolio managers. HILLS TO CLIMB The first is this persistently inverted yield curve, which is now more than 2 years old. This makes decision-making dicier: Extend, and forego current income for future total return benefits, or stay short and invest at today’s higher yields, and accept some reinvestment risk? The second is the still-to-be-determined outcome of the great deposit shuffle, which really began with Silicon Valley Bank’s demise in March 2023. The disintermediation of core deposits continues. Many community banks have, for the first time ever, entered the brokered deposit market. FHLBank system advances nearly tripled between March 2022 and March 2023, from $375 million to $1.04 trillion. The third is the hefty unrealized losses as quantified in the AOCI account at virtually all depositories. As of the end of June, those losses are still in the neighborhood of 12% of face value. This number has actually gotten a bit worse since the Fed hit the pause button, as yield spreads have remained historically wide and the effect of the inverted curve has taken root. SIMPLY ELEGANT Here’s what estimable investment managers have noticed: It can pay to rid oneself of option risk. That’s a complicated way to say that the simplest bonds may have the best relative value in mid-2024. So far this year, a large BY JIM REBER, PRESIDENT AND CEO, ICBA SECURITIES 10 | CURRENCY
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