|
|
II.
DIF Investments Results -
Second Quarter 2007
DIF
- During the first half of 2007, the amortized cost (book value)
of the DIF investment portfolio increased by $1.084 billion or by 2.22
percent—from
$48.858 billion on December 31, 2006, to $49.942 billion on June 30, 2007.
Moreover, during the period, the DIF portfolio’s market value increased
by $698 million or by 1.42 percent, from $49.038 billion on December 31,
2006, to $49.736 billion on June 30, 2007.
- The DIF investment
portfolio's total return for the first half of 2007 was 1.866 percent,
approximately 31.2 basis points higher than
the return of the benchmark, the Merrill Lynch 1 - 10 Year U.S.
Treasury Index (Index), which earned 1.554 percent during the same
period. The
outperformance relative to the benchmark can be attributed to two
factors: The strong performance of the DIF investment portfolio’s
Treasury Inflation-Protected Securities (TIPS) holdings, which outperformed
the
benchmark’s conventional securities during the six-month period;
and relatively high yields being earned on overnight investments,
whose return also exceeded the benchmark return.
- During
the second quarter of 2007, staff purchased Treasury securities
on seven occasions, purchasing a total of 15 conventional Treasury
securities.
The purchased securities had a total par value of $5.400 billion,
a weighted average maturity of 9.70 years, a weighted average
duration of 6.96 years, and a weighted average yield-to-maturity
of 4.95 percent.
Consistent with the approved second quarter 2007 investment
strategy, one short-term Treasury note, with a maturity of 1.87 years,
was
designated as AFS. The other 14 securities, with maturities
ranging from 7.94 years to 11.84 years, were designated as held-to-maturity
(HTM). The total cash outlay for the securities was $6.407
billion.
On June 30, 2007, the DIF portfolio’s overnight investment
balance was $978.2 million, which is above the fund’s $150
million target floor balance. Staff continued its recent practice
of holding excess funds in higher yielding overnight investments
as a reasonable short term investment strategy. That said, the June
30, 2007, overnight investment balance was substantially lower than
the March 31, 2007, overnight balance of $3.709 billion, meaning
that staff purchased a larger amount of Treasury securities compared
to the amount of net cash received during the quarter, taking advantage
of the comparatively high Treasury market yields that became available
during much of the latter half of the quarter.
- In line
with consensus expectations, yields should continue to trade
generally within their current range, but with the potential for a
modest rise
from quarter-end levels. Similar to the strategy employed during
the second quarter, during the third quarter of 2007 staff will take
advantage
of instances when yields rise toward the upper end of this trading
range and accordingly would deploy funds into longer-maturity
higher-yielding securities.
The Treasury Market
- During the second quarter of 2007, most conventional Treasury
yields increased. The yield changes appeared to primarily stem from investors’ concerns
that stronger global economic growth may increase inflationary pressures,
thus leading to higher global interest rates. During the quarter, yields
on three-month and six-month T-Bills decreased; the T-Bill yield declines
were the one exception to the general observation noted above. (The yield
decline on T-Bill apparently stemmed from technical factors, such as supply
and demand factors, rather than fundamental factors). The two-year note
yield, which is sensitive to actual as well as anticipated changes in the
federal funds rate, increased by 29 basis points during the second quarter,
reflecting reduced expectations by most market participants for any federal
funds rate cuts later this year. Intermediate-maturity Treasury yields also
increased, with the five-year Treasury note yield increasing 39 basis points
and the ten-year note yield increasing 38 basis points. The Treasury yield
curve ended the second quarter still relatively flat; on June 30, 2007,
the ten-year to two-year yield curve spread was a positive 16 basis points
(compared to a positive seven-basis point spread at end of the first quarter
of 2007). From a recent historical perspective, the curve remains significantly
flatter; over the past five years, this spread has averaged 114 basis points.
- During
the second quarter of 2007, TIPS real yields increased, reflecting
concerns over stronger global economic growth and correspondingly
higher global interest rates. For example, the real yield on the DIF
portfolio’s
shortest-maturity TIPS (with a maturity of under one year) increased
by 182 basis points during the quarter, while the real yield on the
DIF portfolio’s longest-maturity TIPS (with a maturity of a little
under five years) increased by 58 basis points. The real yield on the
ten-year TIPS maturing on January 15, 2017, increased by 45 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 third
quarter of 2007. From a longer-term investment perspective, purchasing
primarily longer-maturity securities could make sense in light of current
and expected
near-term market conditions. Thus, similar to the strategy implementation
during the second quarter, if higher yields become available—either
as a result of a modest upward shift in the yield curve or because of potential
yield volatility—the third quarter 2007 strategy allows for purchasing
comparatively higher-yielding, longer-maturity Treasury securities.
- The DIF portfolio’s
primary reserve target floor balance will remain at $10 billion
for the third quarter
of 2007. The TIPS target limit will also remain at $10 billion,
while the AFS security target limit is being increased from
$9.0 billion to $9.5 billion, to ensure that the primary reserve
target floor balance can be maintained during the remainder
of the year (see attached Approved Investment Strategy).
|
