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II.
Investments Results & Prospective Strategy -
Second Quarter 2005
BIF
- During the first six months of 2005, the book value of the BIF
investment portfolio increased by $494 million or 1.49 percent—from
$33.231 billion on December 31, 2004, to $33.725 billion on June 30, 2005.
- The
BIF investment portfolio's return for the first half of 2005 was
1.45 percent, approximately seven basis points less than the return
of the
benchmark, the Merrill Lynch 1 – 10 Year U.S. Treasury Index, which
earned 1.52 percent during the first half of 2005. The lagging
performance relative to the benchmark can be attributed to two factors.
Approximately
19 percent of the BIF investment portfolio consists of TIPS, which
underperformed relative to conventional Treasury securities during this
period. In addition,
during the period, on average, about four percent of the portfolio
was invested in lower yielding overnight investments, which in an upward
sloping yield environment acts as a drag on investment returns
compared
to the longer-maturity conventional Treasury securities included
in the Merrill Lynch 1 – 10 Year U.S. Treasury Index.
- During
the second quarter of 2005, $120 million (about 25%) of the
BIF’s
$483 million in interest earned on investment securities was
due to its TIPS inflation adjustment. Due mostly to energy
price increases,
the CPI-U—to which the TIPS principal value is indexed—has
increased at a rate above recent historical levels in 2005.
- During the second quarter of 2005, staff purchased new securities
for the BIF portfolio with a total par value of $2.065 billion, a weighted
average maturity (WAM) of 2.55 years, and a weighted average yield-to-maturity
(YTM) of 3.74 percent. At the end of the quarter, the effective duration
of the BIF portfolio was 2.52 years.
SAIF
- During
the first six months of 2005, the book value of the SAIF investment
portfolio increased by $351 million or 2.93 percent—from $11.962
billion on December 31, 2004, to $12.313 billion on June 30, 2005.
- The
SAIF investment portfolio's return for the first half of
2005 was 1.43 percent, approximately nine basis points less
than
the return of the benchmark, the Merrill Lynch 1 – 10
Year U.S. Treasury Index, which earned 1.52 percent during
the first half of 2005. As with BIF, the SAIF investment portfolio’s
lagging performance relative to the benchmark can be attributed
to two factors. Approximately 19 percent of the SAIF investment
portfolio consists of TIPS, which underperformed relative
to conventional Treasury securities during this period. In addition,
during the period, on average, about four percent of the
portfolio
was invested in lower yielding overnight investments, which
in an upward sloping yield environment acts as a drag on
investment returns compared to the longer-maturity conventional
Treasury
securities included in the Merrill Lynch 1 – 10 Year U.S.
Treasury Index.
- During
the second quarter of 2005, $41 million (about 23%) of the
SAIF’s
$175 million in interest earned on investment securities
was due to its TIPS inflation adjustment. Due mostly to energy
price
increases, the CPI-U—to which the TIPS principal value
is indexed—has increased at a rate above recent historical
levels in 2005.
- During
the second quarter of 2005, staff purchased new securities
for the SAIF portfolio with a total par value of $645 million, a
WAM of 2.50
years, and a weighted average YTM of 3.73 percent. At the end
of the quarter, the effective duration of the SAIF portfolio was
2.67
years
The Treasury Market
- During the second quarter of 2005, Treasury bill yields increased,
reflecting increases in the federal funds target rate, while shorter-maturity
Treasury note yields declined modestly, and longer-term Treasury note
yields declined more substantially. The yield on the five-year Treasury
note decreased
47 basis points while the yield decrease for the ten-year note was an
even more substantial 57 basis points. In contrast to the yield declines
on most
conventional Treasury securities, the yield on the five-year TIPS increased
by nine basis points, with shorter TIPS exhibiting even greater yield
increases. The Treasury yield curve continued to flatten during the second
quarter,
with the spread between two- and ten-year securities at just 28 basis
points, lower than the 70 basis point spread at the end of first quarter
of 2005,
and substantially below its five-year average of 153 basis points.
Prospective Strategies
- The current investment strategies provide the flexibility to purchase
a wide range of different Treasury securities with varying maturities,
depending on Treasury market conditions and developments during the third
quarter of
2005, while at the same time ensuring that the portfolios maintain sufficient
liquidity. Given the current sound condition of the banking and thrift
industries, staff continues to reduce both the BIF and SAIF portfolios’ primary
reserve target floors (previously referred to as target floor liquidity balances).
During the third quarter, the BIF portfolio primary reserve target floor was
reduced to $8 billion, from $10 billion during the second quarter; for the
SAIF portfolio, the respective amounts are $2.5 billion reduced from $2.7
billion.
- Similar
to the first and second quarter investment strategies,
if higher yields become available—either as a result
of an upward shift in the yield curve or because of significant
price volatility—the third quarter strategies provide
the flexibility to purchase comparatively higher-yielding,
longer-maturity Treasury securities.
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