September 17, 2020
Central Banks Continue to Hold, but Ready to Act
September 17, 2020
Federal Reserve Board
The Federal Open Market Committee (FOMC) did not formally meet in August, but Chairman Powell did speak at the annual Jackson Hole symposium. As expected, he reaffirmed the belief that rates would be lower for longer and monetary policy would not stifle any potential recovery. Going forward, the Fed plans to let inflation run higher utilizing an “average inflation targeting” approach. This significant change in policy means inflation will be allowed to run “moderately” higher “for some time” before eliciting any potential rate hike. In addition to the aforementioned policy shift, Chairman Powell plans to modify the Federal Reserve’s employment mandate to become more “inclusive” which suggests a greater focus on targeting lower income earners. The FOMC meets on September 16, 2020, which many anticipate will clarify the policy changes referenced at Jackson Hole.
European Central Bank
While no formal policy meeting was held in August, market participants and analysts expect the European Central Bank (ECB) to keep rates and stimulus unchanged. The ECB’s next meeting on September 10, 2020 is highly anticipated, considering the unprecedented policy actions taken by central banks around the world.
Bank of England
The Bank of England (BoE) Monetary Policy Committee (MPC) met in August and voted unanimously to maintain the Bank Rate at 0.10%. In addition, the MPC voted unanimously to maintain its U.K. government bond purchase programs. The MPC illustrated a more optimistic view on the economy as its witnessed improvements in spending, household consumption and the housing market. It also noted global consumption had improved from the lows brought upon by COVID-19. While the BoE kept rates and stimulus unchanged, the Committee “will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit.”
MSLF EURO LIQUIDITY FUND (LVNAV)
The ECB’s pandemic response, including a new and improved targeted longer-term refinancing operation (TLTRO) in June, added a huge amount of excess liquidity to markets and provided funding to the majority of banks at -1%. Given this huge increase in funding provided to banks, the wholesale money markets have responded with an aggressive flattening of the yield curve. The Fund has therefore continued to look for opportunities in longer dates, while maintaining a large allocation of weekly liquidity eligible assets. These higher-rated assets have been complemented with increasing the allocation to covered bonds, as credit markets continue to provide better value than money markets. Therefore, WAM has continued to be traded at the longer end of our target range, around 50 days; however, with the growth of the Fund towards the end of the month, this fell to the mid- to low-40s. Our WAL continues to trade close to the WAM, given a lack of floating rate opportunities in the deeply negative-yielding euro space.
MSLF STERLING LIQUIDITY FUND (LVNAV)
With the MPC meeting leaving interest rates unchanged and seemingly rejecting the use of negative interest rates for the foreseeable future, the Fund continued to seek opportunities in longer dates where possible, keeping the WAM of the Fund at the longer end of our target range at about 50 days. With the Fund size continuing to grow, moving from £4.26 billion to £4.92 billion intra-month, this has meant a slightly increased percentage in overnight securities due to the lack of yield available in a flat yield curve. This higher level of overnight securities was normalised at month end with our normal cyclical outflows. We continue to wait for better opportunities in sterling markets, as the increase in excess liquidity across wholesale markets continues to have a suppressing impact on money market yields.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
Minutes from the July FOMC meeting and comments from Chairman Powell at the annual Jackson Hole symposium cemented the notion that rates will remain on hold for the next few years. With a flat yield curve and spreads remaining tight on the short end of the curve, we predominantly purchased securities that mature inside of year-end, allowing the weighted average life of our portfolios to gradually roll down to approximately 60 days as of the close of the month. Three-month LIBOR held relatively static month-over-month, but was still setting well above where most banks are transacting in the wholesale commercial paper/certificates of deposit market. We remain comfortable managing the portfolios with elevated levels of liquid assets, ensuring that we uphold our mandates of capital preservation and liquidity.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
The stalemate in Congress over the details of a new stimulus package continued throughout the month of August. As no agreement materialized, net Treasury bill pay-downs continued during the month, putting some downward pressure on short yields. Overall, the Treasury bill curve remained flat, with longer yields largely unchanged. We anticipate more Treasury bill supply, but the timing is dependent on the passage of another package. Overnight repurchase agreement rates softened somewhat during the month as we continued to invest in fixed-rate Treasuries largely up to six-month maturities. We continue to ensure high levels of liquidity and 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.