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II.
DIF Investments Results -
Fourth Quarter 2007
DIF
- During 2007, the amortized cost (book value) of the DIF investment
portfolio increased by $1.611 billion or by three percent—from $48.858
billion on December 31, 2006, to $50.469 billion on December 31, 2007. Moreover,
during the period, the DIF portfolio’s market value increased by $3.340
billion or by seven percent, from $49.038 billion on December 31, 2006,
to $52.378 billion on December 31, 2007.
- The DIF
investment portfolio's total return for 2007 was 8.63 percent,
approximately 23 basis points less than its benchmark, the Merrill
Lynch 1 - 10 Year
U.S. Treasury Index (Index), which had a total return of 8.86
percent during the same period. Given the significant rise in Treasury
security
prices during the year reflecting lower market yields, the DIF
portfolio’s
large cash balance acted as a drag on relative total return performance.
- During
the fourth quarter of 2007, consistent with the approved quarterly
Corporate investment strategy, staff deferred purchases of Treasury
securities in light of the comparatively low Treasury yields available
during the quarter. On December 31, 2007, the DIF portfolio’s
overnight investment balance was $4.240 billion, well above its $150
million target floor balance.
The Treasury Market
- During the fourth quarter of 2007, conventional Treasury yields
decreased substantially, reflecting two 25-basis point cuts in federal
funds target rate during the quarter, and reflecting market sentiment for
additional
cuts in the target rate during the first quarter and second quarters
of 2008. In addition, Treasuries also rallied in response to “flight
to quality” trades by investors seeking the relative safety of Treasury
securities. In the fourth quarter, yields on three-month and six-month T-Bills
decreased by 56 basis points and 69 basis points, respectively. The two-year
note yield, which is also sensitive to actual as well as anticipated changes
in the federal funds rate, decreased by 93 basis points, again, reflecting
the aforementioned 50-basis point cut in the federal funds rate and reflecting
expectations for additional rate cuts. Intermediate-maturity Treasury yields
also decreased over the course of the quarter. The yield on the five-year
Treasury note decreased by 80 basis points; the yield on the ten-year Treasury
note decreased by 57 basis points. The conventional Treasury yield curve
steepened during the fourth quarter of 2007; on December 31, 2007, the two-year
to ten-year yield curve had a 97-basis point positive spread (compared to
positive 61-basis point spread at the beginning of the quarter). Over the
past five years, this spread has averaged 99 basis points.
- During
the fourth quarter of 2007, Treasury Inflation-Protected Securities’ (TIPS)
real yields decreased dramatically, reflecting lower actual and anticipated
interest rates and concerns over weak economic growth. In addition,
as the magnitude of the declines in many cases were larger than those
of comparable maturity conventional Treasury yields, such real yield
declines reflect some modest concerns over growing inflationary pressures.
The real yield of the DIF portfolio’s short-maturity TIPS (with
a maturity of a little over one-year at the end of the quarter) decreased
by 130 basis points during the quarter. The real yield on the portfolio’s
longest-maturity TIPS (with a maturity of just over four years) decreased
by 107 basis points. The real yield on the 10-year TIPS maturing on
January 15, 2017, decreased by 57 basis points.
Prospective Strategies
- The current DIF investment strategy provides for purchasing AFS
conventional with maturities of six years or less, for purchasing AFS TIPS,
and for holding excess overnight investments, depending on Treasury market
conditions and developments during the first quarter of 2008. During the quarter,
if appropriate, staff will take advantage of any instances when yields rise
toward the upper end of the recent trading range by purchasing short- to intermediate-maturity
conventional Treasury securities and TIPS. Any securities purchased during
the quarter will be designated AFS. As with recent quarterly investment strategies,
conventional AFS securities will be limited to maturities of six years or
less, as a means to help control fund balance volatility. (See attached Approved
Investment Strategy.)
- As part of the
DIF portfolio’s approved fourth
quarter investment strategy, an objective was established to
reach a $15 billion primary reserve target floor balance over
the near term, with the understanding that this goal would
not be reached until at least the first quarter of 2008. At
the end of the fourth quarter of 2007, the primary reserve
stood at $14.317 billion. The DIF portfolio’s first quarter
2008 investment strategy continues to include this primary
reserve target objective.
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