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II.
DIF Investments Results -
Second Quarter 2008
DIF
- The amortized cost (book value) of the DIF investment portfolio
decreased by $41 million or by 0.08 percent—from $50.469 billion on
December 31, 2007, to $50.428 billion on June 30, 2008. The DIF portfolio’s
market value increased by $95 million or by 0.18 percent, from $52.378
billion on December 31, 2007, to $52.473 billion on June 30, 2008.
- The DIF
investment portfolio's total return for the first half of 2008
was 2.659 percent, approximately 30 basis points more than its benchmark,
the Merrill Lynch 1 - 10 Year U.S. Treasury Index (Index), which
had
a total return of 2.362 percent during the same period. Despite
the DIF portfolio’s large cash balance, which acted as a drag on
total return performance, the DIF portfolio’s Treasury Inflation-Protected
Securities (TIPS) had significantly higher returns than the Index’s
conventional Treasury securities, hence the overall portfolio outperformance.
- During
the second quarter of 2008, consistent with the approved quarterly
DIF portfolio investment strategy, staff deferred purchases of
Treasury securities in light of expected and potential resolution funding
requirements
and the comparatively low Treasury yields. On June 30, 2008,
the DIF portfolio’s overnight investment balance was $9.255 billion,
well above its $150 million target floor balance.
The Treasury Market
- During the second quarter of 2008, conventional Treasury yields
increased dramatically, with the two-year Treasury note posting the most
significant increase. The yield increases appeared to reflect a number
of factors, including concerns over potentially accelerating inflationary
pressures
and rising inflation expectations, an unwinding of so-called flight-to-quality
trades as the recent financial market turmoil appeared to have mitigated,
and a strong consensus opinion that the Federal Reserve is at or near
the end of its easing cycle. During the second quarter of 2008, yields on
three-month
and six-month T-Bills increased by 41 basis points and 67 basis points,
respectively. The two-year note yield, which is also sensitive to actual
as well as anticipated changes in the federal funds rate, increased significantly
by 104 basis points, again, indicating that the Federal Reserve may be
at or near the end of its easing cycle. Intermediate-maturity Treasury yields
also increased over the course of the quarter. The yield on the five-year
Treasury note increased by 89 basis points; the yield on the ten-year
Treasury
note increased by 56 basis points. The conventional Treasury yield curve
flattened during the second quarter of 2008; on June 30, 2008, the two-year
to ten-year yield curve had a 135-basis point positive spread (compared
to positive 183-basis point spread at the beginning of the quarter).
Over the past five years, this spread has averaged 92 basis points.
- During the second
quarter of 2008, Treasury Inflation-Protected Securities’ (TIPS)
real yields increased, although generally to a lesser extent than comparable
maturity conventional Treasury securities
because of rising inflation expectations. For example, the real
yield on the five-year TIPS maturing on July 15, 2013, increased
by
33 basis
points. The real yield on the 10-year TIPS maturing on January
15, 2017, increased by 34 basis points.
Prospective Strategies
- The current DIF investment strategy calls for placing all net proceeds
from deposit insurance assessments, maturing securities, coupon and other
interest payments, and receivership dividends into overnight investments in
anticipation of possibly needing the funds for resolution activities. (See attached Approved
Investment Strategy.)
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