October 25, 2021
October 25, 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 September meeting. While the Federal Reserve (Fed) did not tweak its forward guidance or quantitative easing policies, it did reinforce Chairman Powell’s statements from the Jackson Hole Economic Symposium. Of note, the Fed increased the reverse repurchase (RRP) counterparty limit from $80 billion to $160 billion and signaled that a moderation of their monthly asset purchase program “may soon be warranted.” While Chairman Powell acknowledged that persistent supply bottlenecks are contributing to higher inflation expectations, the Fed maintained its view that the recent inflation pressures are transitory, slightly modifying its press release to read “inflation is elevated, largely reflecting transitory factors.”
The September meeting included an update of the Fed’s summary of economic projections. The 2022 “dot plot” now shows that half of the 18 voting members believe a rate hike is appropriate in 2022, an increase from seven members in the June projection. Only one voting member does not forecast a rate hike in 2023, while 17 out of the 18 voting members expect rates to move above the lower bound. The median expectation for the fed funds rate is 1.0% at the end of 2023. The FOMC added a new data point for 2024, where the median expectation is 1.8% at the end of 2024. The FOMC downgraded its 2021 real gross domestic product (GDP) forecast to 5.9% from 7.0% estimated in June. The downgrade in GDP can be attributed to rising COVID-19 case counts from the delta variant. Additionally, the Committee increased its inflation projections to 4.2% for 2021, up from its June forecast of 3.4%, for personal consumption expenditures (PCE). In addition, it estimates core PCE rising to 3.7% for 2021, higher than the 3.0% forecast in June, but ultimately leveling out marginally above 2% in the years following.
While the Fed downgraded projections for some metrics, it is unlikely to change their expected tapering timeline, barring a substantial surprise in equity markets or non-farm payrolls.
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on September 9, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The committee kept the size of the pandemic emergency purchase program (PEPP) and asset purchase program unchanged. However, the ECB decided to reduce the pace of purchases under the PEPP in response to elevated inflation levels. The release noted, “Governing Council judges that favorable financing conditions can be maintained with a moderately lower pace of net asset purchases under the PEPP than in the previous two quarters.” It will conduct asset purchases with the same flexibility at a reduced pace while ensuring financial conditions remain accommodative and does not risk the economic recovery. The ECB also pointed out it is not required to deploy all the capital within the PEPP. The Governing Council will continue to monitor all incoming data and adjust policy as necessary to stabilize inflation at 2%.
Bank of England1
The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and voted 7-2 in favor of leaving the size of its U.K. government bond purchase program unchanged at the conclusion of its September 23 meeting. Similar to the Federal Reserve, the MPC noted signs of slowing growth against the backdrop of rising COVID-19 case counts and supply constraints. It revised down its third quarter GDP targets by nearly 1.00% since its last report (August). Overall, there is a greater sense of uncertainty from the Bank of England regarding the outlook, which suggests to us officials are adopting a wait-and-see approach.
MSLF EURO LIQUIDITY FUND (LVNAV)
The flattening/inversion of the euro yield curve is now well established and term rates are almost flat from overnight out to 6-months. The European Central Bank’s dovish new forward guidance, as well as the scale of excess liquidity in the system, has done little to abate this. We have seen our overnight deposit levels being reduced by some counterparties, further reducing our capacity. In the run up to quarter-end we reduced our overnight exposure, targeting maturities just beyond both the quarter-end and year-end periods. Tail end bonds have continued to look attractive relative to money market instruments, and we have continued to look for opportunities in this space, particularly for January maturities. These assets were complemented with short-dated commercial paper, which provided a yield pick-up over overnight securities. Fund size was relatively unchanged over the month, increasing from circa €9.6 billion to €9.7 billion, while WAM and WAL largely stayed in the mid to high 40 days.
MSLF STERLING LIQUIDITY FUND (LVNAV)
The sterling yield curve steepened in September following stronger macro data releases and a hawkish Bank of England meeting, where the Monetary Policy Committee noted that “some developments” since the August meeting had strengthened the case for tighter policy. However, movements at the front end of the curve have been dampened by high levels of excess liquidity and year-end pressures, despite markets anticipating an interest rate hike before 2022. There has been a disappointing lack of opportunities in the floating-rate note space. However, we have been active in the secondary markets and will continue to look for further opportunities here. The Fund gained assets early in the month, touching an all-time high of just under £8.0 billion on 8 September, before outflows took the Fund size back down to circa £7.7 billion to close the month relatively unchanged. Weekly liquid assets have remained fairly elevated, as we added a number of eligible assets maturing beyond the year-end crunch period.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
As anticipated, Fed officials left interest rates near zero at the September FOMC meeting, while notably increasing the reverse repurchase (RRP) counterparty limit from $80 billion to $160 billion and signaling that a moderation of their monthly asset purchase program “may soon be warranted.” Throughout the month, broader market volatility caused by concerns over the debt ceiling limit and headlines out of China did not flow through to the money market space, with 3-month LIBOR remaining range-bound near all-time lows and the Fed RRP facility continuing to take daily submissions in excess of $1 trillion, with a new high water mark at $1.605 trillion reached on quarter-end. With a flat yield curve not compensating to extend maturities and take on additional credit and interest rate risk, we remain patient in our investment approach, waiting for dislocations in pricing before putting capital to work. Portfolio WAM (weighted average maturity) and WAL (weighted average life) organically rolled down throughout the month, with weekly liquidity hovering near 60% to end the quarter.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
At the September FOMC meeting, interest rates remained on hold, as widely expected. The Committee’s taper plans were not yet shared with the markets, but the potential for an announcement rose and is expected at some point this year, potentially at the November meeting. Congressional gridlock on the debt ceiling continued all month. The Treasury bill market started to price in some concern as yields moved higher in the mid-October through mid-November bills versus surrounding bills. With no clear path to a debt ceiling resolution, this maturity range would be most affected if the government had a technical default on its obligations. As highlighted in our prior communications, over the summer, we had proactively sold out of all Treasury positions that matured in the months of October and November at attractive bids when the markets were not pricing in concern. Preserving capital is a primary goal in the portfolios, and the risk/ reward of owning October or November Treasuries was not compelling. At quarter-end, the volume in the RRP facility hit a new high at $1.605 trillion, underscoring supply scarcity and a continued lack of attractive investment options. With an extremely flat yield curve (excluding higher bill yields on October and November bill yields as mentioned), we continued to invest a significant amount of cash in overnight repurchase agreements and to manage the portfolios to be responsive to changes in market conditions and interest rate levels.
Past performance is not a reliable indicator of future results. 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.