Market Insights

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June 28, 2021

Will Inflation Surprises Prompt Policy Shifts?

June 28, 2021

Will Inflation Surprises Prompt Policy Shifts?

Market Insights

Will Inflation Surprises Prompt Policy Shifts?

June 28, 2021

Federal Reserve Board¹

Federal Reserve (Fed) Chairman Jerome Powell and the Federal Open Market Committee (FOMC) did not meet in May. Minutes from the April FOMC meeting indicated that officials were cautiously optimistic about the U.S. economic recovery, with some signaling that it would be appropriate to adjust the pace of their asset purchase program. The next meeting is set for June 16, 2021, where the Fed will release an updated summary of economic projections. Investors will want to pay attention to Chairman Powell’s forward guidance, as the U.S. has made significant vaccination progress and more businesses around the country have reopened to the public.

European Central Bank¹

The European Central Bank (ECB) also did not hold a formal policy meeting in May. In the upcoming June meeting, analysts expect the ECB to leave policy and bond buying unchanged. Outside of policy, the ECB’s commentary on the vaccine rollout’s impact on economic data will be highly sought.

Bank of England¹

The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and voted 8-1 to maintain its U.K. government bond purchase program at its May meeting. The MPC positively revised expected first quarter 2021 gross domestic product (GDP) growth to around -1.5%, which is “less weak” than originally anticipated. In addition, the committee revised up its second quarter and full year projections, citing declining COVID-19 case counts, vaccination progress and loosened restrictions on businesses within the U.K. In February, it projected economic activity to return to pre-pandemic levels next year. However, the May press release noted, “GDP is expected to recover strongly to pre-COVID levels over the remainder of this year in the absence of most restrictions on domestic economic activity.” While much more constructive and optimistic, the committee will continue to monitor economic data closely, standing “ready to take whatever additional action is necessary.”

DISPLAY 1: Overnight Rates

DISPLAY 2: LIBOR Rates

Source: Bloomberg

DISPLAY 3: Yield Curves

Source: Bloomberg.

PORTFOLIO STRATEGY

MSLF EURO LIQUIDITY FUND (LVNAV)

Yield curves in euros continue to challenge, with excess liquidity at €4.1 trillion dampening wholesale funding needs. We are again facing a market where the premium to invest beyond overnight is limited until around 6 months in duration. However, we believe some of the better-rated names continue to show value in the 6-month segment, and we have been picking up assets here when capacity allows. At the start of the month, subscriptions took the Fund to over €8.5 billion in asset size, with the inflows mainly being used to build liquidity. Outflows subsequently reduced the Fund asset size back to €8.0 billion, where it fluctuated for the remainder of the month, although weekly liquidity remained at circa 40%. Recently, tail-end bonds, in either covered or senior format, have been slightly harder to source. Despite this, we have continued to take the opportunity to replace maturities in this space when we can, although value is not as obvious as it had been last year and earlier in 2021.

MSLF STERLING LIQUIDITY FUND (LVNAV)

The sterling curve continued to offer opportunities to invest in higher yields in May. This was particularly true of U.S. dollar swapping names, leading the Fund to increase its exposure to higher quality Australian, Canadian and Scandinavian issuers, which are typically AA rated, and were offering better yields than other European issuers. The Fund continued to gain assets throughout May, increasing from circa £5.5 billion to close the month at around £6.3 billion, having broken the £6 billion mark for the first time on 20 May. The positive flows allowed us to be fairly active in trading, adding 3- to 6-month money market assets, yielding 5-8 basis points more than overnight levels. This was complemented by tail-end bonds in fixed and floating rate formats. The WAM and WAL closed the month at 48 and 56 days, respectively, while weekly liquidity was maintained around our target at just over 41%.

MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)

Minutes from the April FOMC meeting indicated that officials were cautiously optimistic about the U.S. economic recovery, with some signaling that it would be appropriate to adjust the pace of their asset purchase program. Due to both fiscal and monetary stimulus, along with reductions at the Treasury General Account, the short end of the yield curve remains flush with cash, pushing spreads tighter month-over- -month. Three-month LIBOR continued to rally throughout the month, ending at another record low of 0.13138% on May 28. Our investment strategy remains consistent with prior months, with a preference to add fixed-rate investments to the portfolios, due to the liquidity and roll-down benefits of that structure, while also avoiding the reset risk associated with floating-rate notes. Weekly liquidity in our portfolios remains elevated, in excess of 50% throughout the month.

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

May marked significant inflows to government money market funds as fiscal stimulus payments and other cash filtered into our markets. Yields on the 1-year U.S. Treasury curve traded inside of 5 basis points or less given the huge demand for front-end investment options. With the extremely low yields in U.S. Treasury securities, we opted to invest most of the portfolio’s net inflows in either short Treasuries or overnight repurchase agreements collateralized by U.S. Treasuries. As such, portfolio duration metrics moved lower by several days in May. We continue to ensure high levels of liquidity and manage the portfolio to be responsive to changes in market conditions and interest rate levels.

12 Month Performance Periods to Latest Month End (%)

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.

¹ Source: Bloomberg.

Global Liquidity Team

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.

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Taper Time

30-Nov-2021

Institutional Distributing and Institutional Accumulation Share Class Risk and Reward Profile

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 May 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.

IMPORTANT INFORMATION

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.

MSIM has not authorised financial intermediaries to use and to distribute this document, unless such use and distribution is made in accordance with applicable law and regulation. MSIM Ireland shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary. If you are a distributor of the Morgan Stanley Liquidity Funds, some or all of the funds or shares in individual funds may be available for distribution. Please refer to your sub-distribution agreement for these details before forwarding fund information to your clients.

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