June 28, 2021
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.”
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.
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.
Institutional Distributing and Institutional Accumulation Share Class Risk and Reward Profile