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II.
DIF Investments Results -
First Quarter 2008
DIF
- The amortized cost (book value) of the DIF investment portfolio
increased by $750 million or by 1.5 percent—from $50.469 billion on
December 31, 2007, to $51.219 billion on March 31, 2008. Moreover, reflecting
the Treasury rally during the period, the DIF portfolio’s market value
increased by $2.113 billion or by 4.0 percent, from $52.378 billion on December
31, 2007, to $54.491 billion on March 31, 2008.
- The DIF investment portfolio's total return for the first quarter
of 2008 was 3.734 percent, approximately 72 basis points less than its
benchmark, the Merrill Lynch 1 - 10 Year U.S. Treasury Index (Index),
which had a total return of 4.455 percent during the same period. Given
the significant rise in Treasury security prices during the quarter,
the DIF portfolio’s large cash balance acted as a drag on total
return performance.
- During
the first quarter of 2008, 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 March 31, 2008, the DIF portfolio’s overnight
investment balance was $8.079 billion, well above its $150 million
target floor balance.
The Treasury Market
- During the first quarter of 2008, conventional Treasury yields
decreased substantially, reflecting three cuts in federal funds target
rate during the quarter totaling 200 basis points, and reflecting market
sentiment
for additional cuts in the target rate during next couple of quarters.
In addition, Treasuries also rallied in response to “flight to quality” trades
by investors seeking the relative safety of Treasury securities. In the
first quarter, yields on three-month and six-month T-Bills decreased by
192 basis points and 191 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 147 basis points, again, reflecting the
aforementioned cuts in the federal funds target rate and reflecting expectations
for additional rate cuts. Intermediate-maturity Treasury yields also decreased
dramatically over the course of the quarter. The yield on the five-year
Treasury note decreased by 100 basis points; the yield on the ten-year Treasury
note decreased by 61 basis points. The conventional Treasury yield curve
steepened during the first quarter of 2008; on March 31, 2008, the two-year
to ten-year yield curve had a 183-basis point positive spread (compared
to positive 97-basis point spread at the beginning of the quarter). Over
the past five years, this spread has averaged 96 basis points.
- During the first
quarter of 2008, Treasury Inflation-Protected Securities’ (TIPS) real yields decreased dramatically, reflecting
lower actual and anticipated interest rates and concerns over weak economic
growth. The magnitude of the declines was in line with the yield declines
of comparable maturity conventional Treasury yields. The real yield of
the DIF portfolio’s short-maturity TIPS (with a maturity of little
under one-year at the end of the quarter) decreased by 169 basis points
during the quarter. The real yield on the portfolio’s longest-maturity
TIPS (with a maturity of just under four years) decreased by 100
basis points. The real yield on the 10-year TIPS maturing on January
15, 2017,
decreased by 65 basis points.
Prospective Strategies
- The current DIF investment strategy provides the flexibility to
purchase a wide range of different Treasury securities with varying maturities,
depending on Treasury market conditions and developments during the second
quarter of 2008. In line with consensus expectations, Treasury yields should
continue to trade generally within their current range, with the potential
for a modest rise from quarter-end levels. During the second quarter of
2008, if appropriate, staff may take advantage of rising yields by purchasing
short-
to intermediate-maturity conventional Treasury securities and TIPS.
- As part of the DIF portfolio’s approved first
quarter 2008 investment strategy, an objective was established
to reach a $15 billion primary reserve target floor balance,
which was achieved; at quarter-end, the DIF portfolio’s
primary reserve stood at $17.208 billion. The DIF portfolio’s
second quarter 2008 investment strategy maintains the strategic
objective of increasing the primary reserve, with newly purchased
Treasury securities being designated AFS.
- The
current DIF investment strategy provides for purchasing AFS
conventional
Treasury securities 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 second quarter of 2008. 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.)
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