September 30, 2020
Central Banks Remain on Hold
September 30, 2020
Federal Reserve Board
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 September meeting. While the Federal Reserve (Fed) pledges continued support to the economy, it noted that economic and employment activity have “picked up in recent months.” Although the Fed’s tone was more optimistic, such activity is still well below pre-COVID figures. Furthermore, regarding forward guidance, the Fed clearly states that rates will remain at current levels until it is confident COVID concerns abate as well as achieving maximum employment and inflation of 2%.
The Fed continues to review policy to allow for higher inflation, which Chairman Powell publicized at the Jackson Hole Symposium in August. Updated language in the September release stated, “With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time and longer-term inflation expectations remain well anchored at 2%.” Market participants view this change as an opportunity for Chairman Powell to maintain an accommodative policy stance for longer to ensure that the Fed’s stability and employment goals are entirely realized before any policy pivot.
In addition to the press release, the Fed released its updated economic projections. Chairman Powell and the FOMC reinforced its 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 13 of the 17 officials expect rates to remain unchanged through 2023. The FOMC now projects real gross domestic product to contract by 3.7% in 2020, but rebound in both 2021 and 2022. The Fed estimates the unemployment rate to decrease to 7.6% in 2020, then recover sharply in the following two years. The committee revised up projections for core Personal Consumption Expenditures (PCE), but do not see inflation rising to 2% until 2023.
Despite having improved projections from June, the Fed will 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 Bank
At the European Central Bank’s (ECB) policy meeting in September, President Lagarde and the policy committee kept the ECB deposit rate unchanged at -0.50%, as expected. Additionally, the committee kept the total size of the Pandemic Emergency Purchase Program at €1.35 trillion and the ECB’s Asset Purchase Program was left unchanged. Moving forward, the committee stated it will “stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry.”
Bank of England
The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% at its September meeting. Subsequently, the MPC voted unanimously to maintain its U.K. government bond purchase programs. The MPC noted that the outlook for the economy was “unusually uncertain.” It also painted a more optimistic picture, noting that economic data was a “little stronger” than expected at its August meeting. However, looking further out remains “unclear.” While the recent increase in COVID-19 cases globally and in the U.K. remain a concern to the MPC, it suggests the potential impact to be “probably on a lesser scale than seen earlier in the year.” Going forward, the committee continues to stand by the economy and remains ready to act to achieve its goals.
MSLF EURO LIQUIDITY FUND (LVNAV)
Money market yields in the euro market have continued the flattening trend seen in recent months after the ECB’s pandemic response injected a huge amount of liquidity into the banking sector. With excess liquidity now over €3 trillion,1 inevitably money market yields have fallen, with essentially a flat curve from overnight to 3-month maturities, and again only limited improvement in longer dates. The Fund has continued its recent strategy of turning to the bond market to seek better relative value, and we have been able to add to our allocation of covered bonds, as well as senior floating-rate notes and medium-term notes. This has been complemented by money market offers which show better relative value than overnight securities. Our overnight allocation was reduced into quarter-end due to the balance sheet restraints by allocating into short-dated government-related entities. However, we would expect overnights to increase again as maturities fall due in the new quarter.
MSLF STERLING LIQUIDITY FUND (LVNAV)
Despite Bank of England MPC members’ persistent reassurance that negative interest rate policy is not likely to be utilised in the short term, money market yields continue to price in this possibility, with an entirely flat or inverted yield curve now seemingly the norm for the sterling market. Given the low yields on offer, we have limited trading to shorter-dated money market assets to limit the amount of overnight securities being carried, and complemented this with opportunistic trading in tail-end bonds and floating-rate notes. This has seen the WAM of the Fund stay in the high 40s, with the WAL lengthened to 58 days by quarter-end. The Fund has continued its recent strong asset growth, breaking through £5 billion for the first time and peaking at £5.2 billion intra-month before cyclical outflows at month-end saw the Fund finish the quarter at €4.7 billion in assets.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
The Federal Reserve left interest rates near zero at the September FOMC meeting, while signaling it would hold them there through at least 2023 to help the economy recover from the COVID-19 pandemic. Notably, the Fed indicated that it is targeting an average inflation rate of 2% over time, reflecting the new policy framework which allows for an overshoot of its target following periods of sub-2% inflation. 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 (WAL) of our portfolios to gradually roll down to approximately 55 days as of the close of the month. Intra-month, 3-month LIBOR touched all-time lows of 0.21788% on September 25 but were still setting well above where most banks are transacting in the wholesale commercial paper/certificates of deposit market. We remain comfortable managing the portfolio with elevated levels of liquid assets, seeking to ensure that we uphold our mandates of capital preservation and liquidity.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
At the September meeting, the FOMC released economic forecasts that imply no change to interest rates through at least 2023. The FOMC “will aim to achieve inflation moderately above 2% for some time” and plan to keep rates low until inflation averages 2% over an unspecified period. Not unlike last month, markets continued to wait for an outcome on another fiscal stimulus package but the impasse in Washington continued. The Treasury bill curve remained very flat with only a few basis points spread between 1-month and 1-year bill tenors. We continued to invest in fixed-rate Treasuries largely up to 6-month maturities in the portfolio. We continue to seek to ensure high levels of liquidity and manage the portfolio to be responsive to changes in market conditions and interest rate levels.