Changing regulations have effectively ended money market funds as we know them. But with short-term interest rates pegged at zero, where do investors park their cash?
There is perhaps no man better positioned to answer this question than Jerome Schneider. A rising star in the fixed-income universe, Schneider—managing director and head of short-term portfolio management at PIMCO—was named Morningstar’s Fixed Income Manager of the Year in 2015 for his talent in navigating these difficult waters. He is also the manager of the largest active ETF, the $5 billion PIMCO Enhanced Short Maturity Active ETF (MINT), as well as its sister fund, the PIMCO Low Duration Active ETF (LDUR).
Ahead of his keynote speech at the Inside Fixed Income conference in Newport Beach on Nov. 2, Schneider sat down with Inside ETFs’ John Swolfs to discuss where rates are going, what’s going to happen to money market funds, and how investors should position their portfolios
Inside ETFs: What did we learn from the Fed’s last meeting?
Jerome Schneider: The main takeaway from this September meeting is that the decision to raise rates or not is now a closer call than it has been in previous meetings. A growing number of people on the committee are getting more comfortable with the potential for a Fed rate hike later this year. It seems to be a growing, ever-likely probability that we’ll have a Fed increase later on this year.
Inside ETFs: Earlier this year, your expectations were for multiple interest hikes this year. Where are we now?
Schneider: We see an improving growth pattern here in the United States, with growth basically returning to between a 2% and a 2.5% range in 2017. So ultimately we think the Fed will raise rates at least two to three times between now and the end of 2017.
The market’s basically pricing in one hike through that time period, so we’re probably a little bit higher than the market’s expectations for a Fed rate hike. But that’s been the case for some time.
Inside ETFs: What are your expectations for inflation going forward?
Schneider: There's been a dialogue within the Fed itself with regard to how to view inflation and, more importantly, the divergence between indicators of inflation. We think there are reasons inflation will continue to increase over the next year.
Wage pressures have started to develop as labor slack continues to erode. So, while we don’t see inflation getting out of control, we do expect it to reach the landing zone where the Fed can feel comfortable raising rates over the next year.
Inside ETFs: What can investors do to be better positioned to guard against inflation?
Schneider: I think there's a more fundamental approach that investors need to take, especially retail investors. For the better part of the past 10 years, inflation has been on the back burner. It’s humming along, under 2%; not really a threat to people.
As inflation moves higher, investors who use strategies for safekeeping—specifically money market funds—need to realize low rates also impede their purchasing power for future purchases.
They need to think about ways to close that gap, including ways that produce income and other short-term strategies that might hopefully achieve positive real returns over the foreseeable future. That’s a structural change that investors, retail and institutional, have to cope with over the coming months and years as we expect rates to stay lower for longer.
Inside ETFs: What risks do you see for fixed-income investors in 2017?
Schneider: The biggest danger I see is assuming that one singular strategy (whether it’s an index-based approach or a pure play credit strategy) will be able to navigate the cross currents of macroeconomic policies that are potentially coming over the course of the next year.
We have to be active in terms of how we want to think about our allocations and, most importantly, be able to adapt to the changing conditions we see.
It’s going to have to take specific selection in terms of credit, specific selection in terms of different asset classes, to make this work. There might be times where credit outperforms during the course of the year. There might be times where we like interest rate exposure during the course of the year.
But we have to all be nimble enough and have enough degrees of freedom to actively adapt to what’s going on. That’s what we do in MINT and LDUR. The purpose of capital preservation is to protect it for future use, and preserving the purchasing power of that capital has to be a primary tenet of any short-term strategy at this juncture.