Top of mind recently has been the importance of portfolio liquidity. I’ve commented on this several times in recent posts—most recently in last week’s note on the changes in state and local government investment portfolios reported in the Federal Reserve’s release on Financial Accounts of the United States. The events this week could not be more to the point. We’re in for an uncertain ride and the best laid plans for state and local government investment portfolios could be upended with little notice.
Monday evening a journalist posted to X a copy of a two-page memo from the Office of Management and Budget that announced a temporary pause, beginning at 5:00 PM (eastern time) Tuesday of all Federal grants, loans, and financial assistance other than payments made directly to individuals. After a short interval, several of the politically-tuned news sites posted stories with medium-sized headlines that were mixed in with the “usual” Washington news of the day, but it took several more hours until the news appeared on the leading financial or general news sites, thus making it into the broader public domain.
By Tuesday morning the Government Finance Officers Association had a bulletin and post on their website, but it was limited to a link to the OMB memo. (Through the day GFOA posted some additional information including a 50+page spreadsheet that identified specific Federal programs that would be implicated.) By late Tuesday, the news had headlines like this: “Trump’s spending freeze spreads chaos across US.” Meanwhile a Federal judge issued a temporary injunction that put a hold on the suspension for now. At mid-day Wednesday the Trump administration had rescinded the order.
Tuesday was not a fun day for financial managers at the 90,000 state and local governments to think through, prep for and implement the response to a temporary interruption in what represents in the aggregate more than a quarter of their revenue.
It’s not just the reach or substance of potential changes in Federal fiscal policy, but the suddenness and absence of advance signals that would afford government financial managers the ability to make and revise plans. Financial managers scrambled to understand the implications of the memo, and to decide whether to pause or prorate their spending or to continue spending in anticipation of a resumption and catch-up in related Federal payments.
The OMB memo did not set a date for resumption, but it appeared from the context of the memo that it would be sometime after February 10. It also implied future payments could be reduced by amounts the Trump administration determined were in programs implicated by a number of its just-issued executive orders.
What does this have to do with portfolio management? The simple answer is that a pause in Federal assistance for multiple (even if not all) programs can quickly challenge the best laid cash planning, leading to calls for portfolio cash to advance/support payments. Whether and how much will be a hard call by financial managers, and their already difficult decisions should not be constrained by portfolio cash flows.
What to do? Cash flow planning is key. Last week I suggested that portfolio managers address this planning question: “Am I prepared for a [20] % drawdown of investment balances over the next year?” The 20% was not a fixed percentage but a placeholder for a figure that would create a meaningful, if temporary, reordering or reduction in revenue.
No, the sky need not fall to invoke this question. Over the balance of the year, we could see:
There are some elaborate cash flow models out there and some investment managers and consultants offer this as a service. That’s well and good, but without seeming like a Know Nothing, common sense back of the envelope estimates work as well. After all, the question is "if things do not go according to plan how much liquidity will I need in my portfolio?”
Keep in mind that in the current market there is little if any cost to liquidity. The Treasury yield curve is extraordinarily flat, with only about 25 basis points separating the low and high yields within the two-year maturity space. And in fact, the highest yield is for very short maturities. Of course, that implies the risk that rates will be lower later in the year but at this point public funds portfolio managers would be well served to put a premium on liquidity.
**This is updated to reflect the recission of the OMB order mid-day Wednesday.