April 23, 2021
Central Banks Tolerate Rise in Long-Term Rates
April 23, 2021
Federal Reserve Board1
As expected, the Federal Open Market Committee (FOMC) kept the range for the federal funds rate unchanged at 0.00% to 0.25% at the conclusion of its March meeting. The Federal Reserve (Fed) did not tweak its forward guidance or quantitative easing policies. The March press release remains consistent with prior meetings but with a more upbeat assessment of the pace of the economic recovery. Having previously characterized the recovery as moderating at the January meeting, the Fed noted in its March statement “following a moderation in the pace of the recovery, indicators of economic activity and employment have turned up recently.”
In addition to the press release, the Fed introduced an updated summary of economic projections. Chairman Powell and the FOMC reiterated current forward guidance and accommodative policy with its updated dot plot, which illustrates that 14 out of 18 officials expect to keep rates at current levels through 2022, while 11 of the 18 officials expect rates to remain unchanged through 2023. The FOMC increased its real gross domestic product projection to 6.5% in 2021 from 4.2% in December. The Fed estimates the unemployment rate will decline to 4.5% in 2021 and continue to improve in the following two years. The committee projects core Personal Consumption Expenditures to rise slightly above 2% in 2021, but ultimately level out at 2% over the course of 2022 and 2023.
Although the Fed acknowledges improved economic data and reiterated optimistic sentiment with improved economic projections, it continues to stand by the economy in case expectations are mired by the ongoing COVID-19 pandemic or projections don’t materialize.
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on March 11, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The committee kept the size of its pandemic emergency purchase program (PEPP) and asset purchase program unchanged in March. In response to rising yields, the release noted, “the Governing Council expects purchases under the PEPP over the next quarter to be conducted at a significantly higher pace than during the first months of this year.” The ECB views its current monetary policy as appropriate and will remain accommodative until inflation moves towards its mandate.
Bank of England1
The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and its U.K. government bond purchase program at its March meeting. Like other central banks, the MPC acknowledged higher global sovereign yields, saying, “longer-term government bond yields have risen rapidly to levels similar to those seen shortly before the pandemic. For the most part this has reflected higher real yields.” The committee believes the vaccine rollout and easing restrictions in the U.K. to be significant tailwinds for the economy in the short term. While the press release portrays a bit more optimism, the MPC notes the outlook is “unusually uncertain.”
MSLF EURO LIQUIDITY FUND (LVNAV)
March activity was, as usual, dominated by preparation for quarter-end constraints, as balance sheet availability for overnight deposits is limited. The Fund was well positioned for this quarter-end client activity, with the daily liquid assets gradually falling to circa 30% towards the end of March. Despite this, our weekly liquidity was bolstered going into quarter-end as we pivoted towards investments in weekly eligible assets. We continue to look at term investment and covered bonds as a source of yield pick-up where we are able to find potentially attractive opportunities. With the seventh TLTRO III (targeted longer-term refinancing operations) settling on 24 March, pushing excess liquidity towards €4 trillion, there are expectations for further pressure on the yield curve in the coming months. The Fund’s weighted average maturity (WAM) extended over the month, increasing from 45 to 51 days, whilst the weighted average life (WAL) rose from 47 to 52 days. This extension was, however, partly due to outflows, with the Fund assets under management size falling circa €800 million.
MSLF STERLING LIQUIDITY FUND (LVNAV)
Following the Bank of England MPC meeting in February implying that negative interest rates were highly unlikely in the U.K. for the foreseeable future, there was a gradual pick up in yields across the curve. This has continued after March’s neutral MPC comments. In an effort to increase the Fund’s yield with the improving market, the WAM and WAL were extended towards the end of the month, reaching 52 and 58 days, respectively, as we saw attractive opportunities in the 3- to 6-month space. However, both the WAM and WAL still finished March slightly lower than at the end of February. This was largely a function of strong inflows, with the Fund gaining circa £1.5 billion in assets to close the month at around £4.6 billion. We continue to maintain good levels of liquidity in the Fund.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
Fed officials kept interest rates near zero and made no changes to their asset purchase program at the March FOMC meeting, while observing “indicators of economic activity and employment have turned up recently, although the sectors most adversely affected by the pandemic remain weak." The Fed’s dot plot continues to show that most officials expect no change to borrowing costs through 2023. Intra-month, volatility in the Treasury market did not flow through to the money market space, with spreads remaining tight and 3-month LIBOR remaining range bound between 18 and 20 basis points. We maintain our strategy of adding fixed-rate investments to the portfolio, due to the liquidity and rolldown benefits of that structure. Weekly liquidity in our portfolios remains elevated, in excess of 50% throughout the month.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
During March, Treasury bill and repo yields remained very low with overnight SOFR coming in at 1 basis point the entire second half of the month. While there was some additional Treasury bill supply after the stimulus passed, it merely served to slow the pace of net bill paydowns with minimal yield impacts. The demand from the abundance of cash in the front end continued to overtake investment options, keeping the 1-year Treasury curve under 7 basis points. At the March meeting, the FOMC made modest changes to its statement and left the federal funds target range unchanged at zero to 25 basis points. The FOMC changed the size of the overnight reverse repo (RRP) operations participation limit, increasing the cap from $30 billion to $80 billion per counterparty, to support a floor on short rates. At quarter-end, the RRP rose to $134.307 billion in volume, underscoring this dynamic and highlighting reduced dealer repo availability. We continued to be proactive in extending maturities when relative value prevails, opting to purchase Treasuries across the yield curve while keeping a fair amount in overnight repos collateralized by U.S. Treasuries. We continue to ensure high levels of liquidity and manage the portfolio to be responsive to changes in market conditions and interest rate levels.
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