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January 25, 2022

Fed Speeds Up Tapering, While BoE Increases Rates

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January 25, 2022

Fed Speeds Up Tapering, While BoE Increases Rates


Market Insights

Fed Speeds Up Tapering, While BoE Increases Rates

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January 25, 2022

 
 

Federal Reserve Board1

The Federal Open Market Committee (FOMC) voted unanimously to keep the federal funds rate unchanged at a range of 0.00% to 0.25% at the conclusion of its December meeting. Of particular note, and in line with recent market expectations, the Federal Reserve (Fed) announced that it would accelerate the winding down of its asset purchase program, increasing the reduction from $15 billion to $30 billion a month. This puts the Fed on pace to conclude the program around March 2022.

The December meeting included an update of the Fed’s summary of economic projections. The 2022 “dot plot” now shows all 18 voting members believe a rate hike is appropriate in 2022, an increase from nine members in the September projection. The median expectation for the fed funds rate is 1.6% and 2.1% at the end of 2023 and 2024, respectively. The FOMC downgraded its 2021 real gross domestic product (GDP) forecast to 5.5% from 5.9% estimated in September. The downgrade in GDP can be attributed to rising COVID-19 case counts and supply chain bottlenecks. Additionally, the Committee increased its inflation projections to 5.3% for 2021, up from its September forecast of 4.2%, for personal consumption expenditures (PCE). 2022 PCE projections increased 40 basis points to 2.6%. In addition, the Fed estimates core PCE rising to 4.4% for 2021, higher than the 3.7% forecast in September, but ultimately leveling out marginally above 2% in the years following.

European Central Bank1

At the European Central Bank’s (ECB) policy meeting on December 16, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The committee left the total size of the pandemic emergency purchase program (PEPP) and asset purchase program (APP) unchanged. However, the ECB noted it would reduce the pace of purchases under the PEPP in the first quarter. The release noted, “progress on economic recovery and towards its medium-term inflation target permits a step-by-step reduction in the pace of its asset purchases over the coming quarters.” Purchases under the PEPP will end in March 2022. Similarly, the Governing Council will reduce the size of purchases under the APP by €10 billion a quarter until October 2022 where purchases will level off at €20 billion a quarter for “as long as necessary to reinforce the accommodative impact of its policy rates.”

Bank of England1

The Bank of England (BoE) Monetary Policy Committee (MPC) voted 8-1 to increase the Bank Rate 0.15% to 0.25% in response to elevated inflation. The MPC unanimously voted to leave the size of its U.K. government bond purchase program unchanged at the conclusion of its December 16 meeting. The committee was undeterred by the omicron variant, although noted it “poses downside risks in early 2022.” Policy will continue to focus on the medium term as policy decisions and inflation impacts tend to lag each other. Looking forward, the BoE will remain attentive to incoming data and expects “inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022.”

 
 
 
DISPLAY 1: Overnight Rates
 

Source: Bloomberg

 
 

Portfolio Strategy

MSLF EURO LIQUIDITY FUND (LVNAV)

As expected, year-end provided a number of challenges for short-end money markets as the lack of collateral available for overnight reverse repo and the lack of balance sheet capacity for overnight deposits combined to make a historically difficult year-end for short-term rates. Overnight repo trades cleared as low as -7% while even the more stable deposit rates went through the -1% barrier. Given this, much of the investment in December was about re-allocating liquidity from overnight into weekly liquid eligible assets such as government agency and treasury bills. Most of this was done with a short maturity focus, in 1-month or shorter bills. Opportunities outside these trades were therefore limited as bank issuance dried up in the run-up to year-end, and only a limited number of assets were purchased in either money market instruments or tail-end bonds. Given the rate environment, we continued to see investors choose to utilise money market funds as their preferred year-end investment, taking the Fund asset size to around €12 billion by year-end.

MSLF STERLING LIQUIDITY FUND (LVNAV)

Following the surprise hold in November, the MPC’s duly delivered rate hike in December was a little against market expectations, and given the proximity to year-end, the impact of the 15 basis point hike was not immediately seen in short-end markets. Year-end pressures dominated with zero or negative yields still prevalent even after the hike. As is fairly typical in sterling markets, however, outflows in the run-up to year-end eased pressure on our overnight capacity constraints and meant the Fund did not have to trade at negative rates in overnight securities at year-end. The Fund’s assets under management ended the year at a record year-end high of £7.8 billion after reaching a high of £8.8 billion intra-month.

 
 
DISPLAY 2: LIBOR Rates
 

Source: Bloomberg

 
 
DISPLAY 3: Yield Curves
 

Source: Bloomberg

 
 

The WAM (weighted average maturity) and WAL (weighted average life) also rose due to the year-end outflows, finishing the year at 56 days and 68 days, respectively.

MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)

On the month we purchased both fixed- and floating-rate securities, with fixed tenors in the first half of 2022 and floating-rate securities with maturities in the second half of 2022, that reset off of the SOFR index with coupons that will immediately reprice in the event the Fed hikes rates. Our portfolio ended the month with a WAM on the lower end of the peer group and with weekly liquidity on the higher end of the peer group near 60%.

MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)

As we typically see at year-ends, supply constraints emerged from dealers on repo availability due to balance sheet limitations and from overwhelming demand for short bills by investors. Short-dated Treasuries rallied heading into the last week of the year as investor demand overtook attractive investment options overall. We took this opportunity to sell select Treasuries at attractive bids, reinvesting most of the proceeds into overnight repurchase agreements or bill auctions, to a lesser extent. Just before their holiday recess, Washington legislators agreed to a procedural path to resolve the debt ceiling. The debt limit was increased by $2.5 trillion and pushed off another episode until after the midterm elections. This allowed the U.S. Treasury to increase supply heading into year-end, which moved auction stop-out yields slightly higher on supply increases. Market expectations continued to rise in anticipation of multiple rate hikes in 2022 by the FOMC and on their action to speed up and end asset purchases in March 2022. The portfolio’s duration fell during December as we sold the aforementioned positions and structured the portfolio for expected multiple rate hike actions in 2022. We continued to manage the portfolio to be responsive to changes in market conditions and interest rate levels.

 
 
Calendar Year Performance (%)
 

The net performance data shown is calculated net of annual fees. The sources for all performance and Index data is Morgan Stanley Investment Management. Please visit our website www.morganstanley.com/im to see the latest performance returns for the fund’s other share classes.

 
 

1 Source: Bloomberg.

 
 
 
The Global Liquidity team aims to effectively meet clients’ unique cash and working capital needs, offering a broad range of money market funds, ultra short bond funds and customized separate account solutions.
 
 
 
 
 

IMPORTANT INFORMATION

This is a marketing communication. Applications for shares in the Fund should not be made without first consulting the current Prospectus and the Key Investor Information Document (“KIID”), which are available in English and in the official language of your local jurisdiction at https:// www.morganstanley.com/pub/content/imweb/im/en-gb/liquidity-investor/ or free of charge from the Registered Office of Morgan Stanley Liquidity Funds, European Bank and Business Centre, 6B route de Trèves, L-2633 Senningerberg, R.C.S. Luxemburg B 29 192. A summary of investor rights is available in English at the same website.

If the management company of the relevant Fund decides to terminate its arrangement for marketing that Fund in any EEA country where it is registered for sale, it will do so in accordance with the relevant UCITS rules.

The risk and reward category shown is based on historic data.

  • Historic figures are only a guide and may not be a reliable indicator of what may happen in the future.
  • As such this category may change in the future.
  • The higher the category, the greater the potential reward, but also the greater the risk of losing the investment. Category 1 does not indicate a risk free investment.
  • The fund is in this category because it invests in money market securities and the fund’s simulated and/or realised return has experienced low rises and falls historically.

This rating does not take into account other risk factors which should be considered before investing, these include:

  • The value of bonds are likely to decrease if interest rates rise and vice versa.
  • Issuers may not be able to repay their debts, if this happens the value of your investment will decrease. This risk is higher where the fund invests in a bond with a lower credit rating.
  • The fund relies on other parties to fulfill certain services, investments or transactions. If these parties become insolvent, it may expose the fund to financial loss.
  • While it is intended that the distributing share classes will maintain a share price of €1/$1/£1 this may not be achieved due to the creditworthiness of the issuers of investments held or changes in interest rates.

Past performance is no guarantee of future results.

Please refer to the Prospectus for full risk disclosures. All data as of 31 December 2021 and subject to change daily.

INDEX INFORMATION

One week Euro LIBID Index – One week London Interbank Bid Rate - The average interest rate which major London banks borrow Eurocurrency deposits from other banks. One Month Euro LIBID Index – One month London Interbank Bid Rate - The average interest rate which major London banks borrow Eurocurrency deposits from other banks. Euro Overnight Index Average (EONIA) – the standard interest rate at which banks provide loans to each other with a duration of 1 day within the Eurozone. FTSE 1 Month Treasury Bill Index – index calculated by FTSE that is an average of the last one month Treasury bill month-end rates. One Week USD LIBID Index – 1 week London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. One Month USD LIBID – 1 month London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. FED Funds – excess cash reserves that commercial banks and other financial institutions deposit at regional Federal Reserve banks; these funds can be onward lent to other market participants with insufficient cash on hand to meet their lending and reserve needs. One Week GBP LIBID Index – 1 week London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. One Month GBP LIBID – 1 month London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. SONIA – the standard interest rate at which banks provide loans to each other with a duration of 1 day within the Sterling market.

DEFINITIONS

Weighted average maturity (WAM) – measures the weighted average of the maturities of the portfolio’s individual holdings, taking into account reset dates for floating rate securities. Weighted average life (WAL) – measures the weighted average of the maturities of the portfolio’s individual holdings. Public Debt Constant Net Asset Value (CNAV) MMF – a MMF qualifying and authorised as a Public Debt CNAV MMF in accordance with MMF Regulation which seeks to maintain a stable NAV and invests 99.5% of its assets in money market instruments issued or guaranteed by sovereign entities, reverse repurchase agreements secured with government debt and cash. Low Volatility Net Asset Value (LVNAV) MMF – a MMF qualifying and authorised as a LVNAV MMF in accordance with MMF Regulation which seeks to maintain a stable NAV under the condition that the stable NAV does not deviate from the NAV per Share by more than 20 basis points. In case of a deviation of more than 20 basis points between the stable NAV and the NAV per Share, the following redemption or issue of Shares shall be undertaken at a price that is equal to the NAV per Share.

DISTRIBUTION

This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations. In particular, the Shares are not for distribution to US persons.

Ireland: MSIM Fund Management (Ireland) Limited. Registered Office: The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. Registered in Ireland as a private company limited by shares under company number 616661. MSIM Fund Management (Ireland) Limited is regulated by the Central Bank of Ireland. United Kingdom: Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA, authorised and regulated by the Financial Conduct Authority. Dubai: Morgan Stanley Investment Management Limited (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai  International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158). Germany: MSIM Fund Management (Ireland) Limited Niederlassung Deutschland, Grosse Gallusstrasse 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Italy: MSIM Fund Management (Ireland)Limited, Milan Branch (Sede Secondaria di Milano) is a branch of MSIM Fund Management (Ireland) Limited, a company registered in Ireland, regulated by the Central Bank of Ireland and whose registered office is at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. MSIM Fund Management (Ireland) Limited Milan Branch (Sede Secondaria di Milano) with seat in Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy, is registered in Italy with company number and VAT number 11488280964. The Netherlands: MSIM Fund Management (Ireland) Limited, Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. Telephone: 31 2-0462-1300. Morgan Stanley Investment Management is a branch office of MSIM Fund Management (Ireland) Limited. MSIM Fund Management (Ireland) Limited is regulated by the Central Bank of Ireland. France: MSIM Fund Management (Ireland) Limited, Paris Branch is a branch of MSIM Fund Management (Ireland) Limited, a company registered in Ireland, regulated by the Central Bank of Ireland and whose registered office is at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. MSIM Fund Management (Ireland) Limited Paris Branch with seat at 61 rue de Monceau 75008 Paris, France, is registered in France with company number 890 071 863 RCS. Spain: MSIM Fund Management (Ireland) Limited, Sucursal en España is a branch of MSIM Fund Management (Ireland) Limited, a company registered in Ireland, regulated by the Central Bank of Ireland and whose registered office is at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. MSIM Fund Management (Ireland) Limited, Sucursal en España with seat in Calle Serrano 55, 28006, Madrid, Spain, is registered in Spain with tax identification number W0058820B.  Switzerland: Morgan Stanley & Co. International plc, London, Zurich Branch Authorised and regulated by the Eidgenössische  Finanzmarktaufsicht (“FINMA”). Registered with the Register of Commerce Zurich CHE-115.415.770. Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland, Telephone +41 (0) 44 588 1000. Facsimile Fax: +41(0) 44 588 1074.

EMEA: This marketing communication has been issued by MSIM Fund Management (Ireland) Limited. MSIM Fund Management (Ireland) Limited is regulated by the Central Bank of Ireland. MSIM Fund Management (Ireland) Limited is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson’s Quay, Dublin 2, D02 VC42, Ireland.

This document contains information relating to the sub-fund (“Fund”) of Morgan Stanley Liquidity Funds, a Luxembourg domiciled Société d’Investissement à Capital Variable. Morgan Stanley Liquidity Funds (the “Company”) is registered in the Grand Duchy of Luxembourg as an undertaking for collective investment pursuant to Part 1 of the Law of 17th December 2010, as amended. The Company is an Undertaking for Collective Investment in Transferable Securities (“UCITS”).

The Funds are not a guaranteed investment and are different from an investment in deposits. The Funds do not rely on external support for guaranteeing the liquidity of the Funds or stabilising the NAV per share. The value of investments and the income from them may go down as well as up and you may not get back the amount you originally invested.

The Funds are authorised to invest up to 100% of their assets in Money Market Instruments issued or guaranteed separately or jointly by a Sovereign Entity and by any other member states of the OECD and their central authorities or central banks subject to certain conditions. Please see Prospectus for further details.

Applications for shares in the Funds should not be made without first consulting the current Prospectus, Key Investor Information Document (“KIID”), Annual Report and Semi-Annual Report (“Offering Documents”), or other documents available in your local jurisdiction which is available free of charge from the Registered Office: European Bank and Business Centre, 6B route de Trèves, L-2633 Senningerberg, R.C.S. Luxemburg B 29 192.

Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

The views and opinions expressed are those of the portfolio management team at the time of writing/of this presentation and are subject to change at any time due to market, economic, or other conditions, and may not necessarily come to pass. These comments are not representative of the opinions and views of the firm as a whole. Holdings, countries and sectors/region weightings are subject to change daily. All information provided is for informational purposes only and should not be deemed as a recommendation to buy or sell securities in the sectors and regions referenced. Information regarding expected market returns and market outlook is based on the research, analysis, and opinions of the team. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific Morgan Stanley Investment Management investment. Past performance is no guarantee of future results.

The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the applicable European or Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.

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This is a Marketing Communication.

Please be aware that liquidity instruments may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall. In a declining interest-rate environment, the portfolio may generate less income.

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