January 27, 2021
Rising COVID-19 Cases Prompt Central Banks to Extend Aid
January 27, 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 December meeting. Much of the meeting’s focus related to forward guidance and the asset purchase program. The Federal Reserve (Fed) reiterated it will “continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” Effectively signifying that until both maximum unemployment and consistent 2% inflation is met, the Fed will continue asset purchases.
In addition to the press release, the Fed updated its economic projections. Chairman Powell and the FOMC reinforced their forward guidance and accommodative policy stance with the updated dot plot, which illustrates that 16 out of 17 officials expect to keep rates at current levels through 2022, while 12 of the 17 officials expect rates to remain unchanged through 2023. The FOMC projects real gross domestic product (GDP) to contract by 2.4% in 2020, but rebound in both 2021 and 2022. The Fed estimates the unemployment rate will decrease to 6.7% in 2020, then recover sharply in the following two years. The committee marginally increased projections for core Personal Consumption Expenditures, but does not see inflation rising to 2% until 2023. While many of these figures were positively revised since September, the FOMC plans to use “its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.”
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on December 10, President Lagarde and the policy committee kept the ECB deposit rate unchanged at -0.50%, as expected. The Committee increased the total size of the Pandemic Emergency Purchase Program (PEPP) by €500 billion, bringing the total size of the program to €1.85 trillion, and extended the facility through March 2022, while it left the Asset Purchase Program (APP) unchanged. Market participants had expected the ECB to act, as this modification was telegraphed in prior meetings to offset the negative impacts of a second lockdown and weakening economic data. Additionally, targeted longer-term refinancing operations (TLTRO III) were extended until June 2022 and four pandemic emergency longer-term refinancing operations (PELTROs) will be offered in 2021.
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 December meeting. The MPC noted that the second set of lockdowns and increasing COVID-19 case count would negatively weigh on economic data. The committee believes fourth quarter GDP will be slightly weaker than anticipated, but is developing a more optimistic view with the vaccine rollout in the first half 2021. The committee believes vaccine rollout procedures will “reduce the downside risks to the economic outlook.” Going forward, the MPC will continue to monitor economic and inflation data while standing ready to take “whatever additional action is necessary to achieve its remit.”
MSLF EURO LIQUIDITY FUND (LVNAV)
With high excess liquidity, reduced balance sheet capacity and December’s ECB meeting adding further monetary stimulus, monetary conditions were very loose going into year end. Consequently, we shifted investments away from overnight deposits and reverse repurchase agreements and into bills and agency paper. This strategy led to an extension of the WAM and WAL at the start of December, whilst maintaining sufficient weekly liquidity (which fluctuated between the mid- 40% and mid-50% range during the month). The Fund’s assets under management continued to grow throughout December and ended the year at circa €10.6 billion, €2.5 billion higher than at the start of the month. These inflows further added to the challenge of finding year-end capacity and impacted the yield as year-end investments moved increasingly expensive.
MSLF STERLING LIQUIDITY FUND (LVNAV)
Year-end issues also dominated sterling markets in December, with few positive-yielding issuers in maturities under 6 months. We mainly relied on secondary issuance to invest at positive yields, although some negative-yielding investments were necessary to invest inflows ahead of year end. With repo rates showing volatility and year end approaching, we were able to reduce overnight liquidity from the mid-40% range, whist maintaining weekly liquidity around the 40% mark. The WAM and WAL increased during the month as we saw significant outflows as we approached year end, finishing the year at 60 and 69 days, respectively (up from 50 and 58 days at the start of the month).
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
The Fed kept interest rates near zero and made no changes to its asset purchases at the December FOMC meeting. Officials indicated that while “economic activity and employment have continued to recover but remain well below their levels at the beginning of the year,” they will continue to support the economy through monetary stimulus until they see substantial progress in employment and inflation. As we approached year-end, technicals on the short end of the curve put slight pressure on the wholesale funding market, driving 3-month LIBOR to its highest level since August, setting at 0.25388% on December 29. In the portfolios, we continue to opportunistically purchase fixed-rate securities across the curve, locking in attractive yields and avoiding reset risk associated with floating-rate securities, as there will likely be downward pressure on LIBOR and SOFR in early 2021. Throughout December and looking ahead, we remain conservatively positioned across our funds, prioritizing elevated levels of weekly liquidity to meet any unexpected volatility.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
In December, U.S. Treasury bill yields remained low and in the single digits across most of the one-year curve. Toward the end of the month, Congress finally passed a $900 billion stimulus package after much debate. Treasury bill yields moved a hint higher then were quickly pushed lower as investor demand for bills increased with year-end approaching. Overnight repo rates remained well behaved as expected over year-end. At the December FOMC meeting, the Committee reiterated that policy will remain accommodative, as it is now, for a long time. Projections for the economy were upgraded somewhat and the monthly Treasury and mortgage securities purchases will continue “at least” at the current pace until substantial further progress is made toward its dual mandate goals. We continued to buy Treasury bills with up to 6-month tenors 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.
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.