August 31, 2021
Central Banks Await More Substantial Economic Progress
August 31, 2021
Federal Reserve Board1
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 July meeting, as expected. While messaging remained generally consistent with the prior month’s meeting, the Federal Reserve (Fed) upgraded its stance on the economy, noting that it has “continued to strengthen.” In consideration of preparing for balance sheet tapering, Chairman Powell indicated that the economy has made progress toward the Fed’s employment and inflation goals but data have not been “sufficient” to warrant policy shifts. Current policy continues to be viewed as “appropriate,” and the committee will “continue to assess progress in coming meetings.”
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on July 22, 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 in July. While monetary policy was held steady, President Lagarde and the Governing Council tweaked their stance on forward guidance. In what’s being viewed as a more accommodative approach, the ECB plans to keep rates at current or lower levels until “inflation is sufficiently advanced to be consistent with inflation stabilizing at 2% over the medium term.
Bank of England1
Although no formal policy meeting was held in July, analysts expect the Bank of England to leave monetary policy and the quantitative easing program unchanged in August. While expectations for policy shifts have been subdued, analysts anticipate the Monetary Policy Committee to portray an optimistic attitude regarding the economy.
MSLF EURO LIQUIDITY FUND (LVNAV)
Half year-end was negotiated comfortably, with the Fund size remaining stable around the €9.0 billion mark and only repos dropping significantly in yield (about 25 basis points lower than normal overnight levels). The flattening/inversion of the euro yield curve continued in July, particularly now that 6-month trades are maturing in January and are therefore more expensive or are simply not being shown by banks. 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. As such, weekly liquidity (which was already elevated due to half-year-end positioning) remained in the mid 40% range for much of the month, as attractive opportunities to extend the Fund have been scarce. Tail-end bonds continue to be difficult to source, although we are still taking the opportunity to replace maturities in this space when we can.
MSLF STERLING LIQUIDITY FUND (LVNAV)
The sterling curve continues to show value, particularly in longer maturities. However, yields for shorter maturities (especially shorter than the 7-month tenor) have fallen recently, with many issuers in 3-month tenors showing levels that are lower than alternatives in overnight. The Fund continued to gain assets during the month, increasing from £7.2 billion to finish July at around £7.6 billion. The inflows have allowed us to add some attractive longer assets in the 9-month and 1-year space, while still adding in 3- and 4-month where there is yield pick-up over overnight. We have also added a further 1-year SONIA floating-rate note and we remain vigilant for more opportunities in this space, as we look to extend the WAL (weighted average life). With the recent longer trades, the WAM (weighted average maturity) ticked up to the low 50 days by the end of the month, so there is also some scope to extend this further. Weekly liquidity has remained elevated and ended July at circa 50%.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
Throughout the month, broader market volatility caused by concerns over the spreading delta variant did not flow through to the money market space, with 3-month LIBOR4 rallying to set at an all-time low of 0.11775% on month-end. With a flat curve not compensating investors 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 and WAL organically rolled down throughout the month, with weekly liquidity remaining elevated in excess of 50%.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
In July, yields remained compressed and the curve flat with most Treasury bill auctions stopping between 0.04% and 0.05%. Extreme amounts of cash in the front end kept short rates well anchored with overnight repo rates steady at 0.05% all month. In the first half of July, we continued buying 6-month bills then largely ceased purchasing these bills in the latter half of the month, as we felt comfortable with current extensions and the portfolio’s duration profile. At month-end, the debt ceiling suspension ended, and in August, the government began using extraordinary measures to remain below the debt limit. We remain vigilant of potential Treasury exposures near the debt ceiling “drop-dead date”. Although the date is a moving target, we currently expect it to be in October. Markets are not pricing any debt limit disturbances yet and we hope Congress will address the limit in short order. In the meanwhile, we sold off several Treasury positions and reinvested into overnight repos or other Treasuries given the lack of much yield effect to do so. We continued to invest a significant amount of cash in overnight repurchase agreements and to 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.
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