Insights
The Times They Are A-Changin'
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Insight Article
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February 04, 2022
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The Times They Are A-Changin'
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February 04, 2022
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The Times They Are A-Changin'
The Times They Are A-Changin' |
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The inevitability of change remains constant with central bank monetary policy, global money market reform, and technological advances expected to drive changes in 2022.
In the U.S., we expect the Federal Reserve to end tapering by mid-March and announce four rate hikes over the course of the new year.
In a potentially rising rate environment, efficient cash management is critical to maximizing economics, both through the investments themselves and technology solutions.
Introduction
Bob Dylan’s classic song, “The Times They Are A-Changin” summoned listeners to look around and recognize that although change is an inevitable and unstoppable force, we are each called to action to adopt. Dylan’s lyrics are certain to resonate with treasury managers as they face major changes in monetary policy, money market funds (MMFs) regulations, sustainability practices, and technology. How cash investors adopt to the onslaught of change may very well determine their success in 2022 and beyond.
Market Overview
Last Fall demonstrated just how quickly change can take place. At the time, financial markets were awash in liquidity, LIBOR was at an all-time low, and there was one Fed interest rate hike on the horizon in late 2022. But in response to persistently elevated prices, the Fed altered their stance on inflation, no longer viewing it as “transitory” but admitting “that prices have remained higher for longer than expected.” At the same time, they announced plans to end their asset purchase program sooner than expected, opening the door for a series of interest rates increases beginning as early as March. The Fed’s current projections suggest three rate hikes this year, another three in 2023, and two more in 2024. Our expectation is relatively in line with the Fed, to have at least 4 rate hikes in 2022 in addition to beginning the gradual reduction of the Fed’s balance sheet. It is important to remember that even with the Fed speeding up their tapering program and rate hikes starting, absolute rates will remain below historic average levels and are simply normalizing from emergency settings.
Positioning for Rising Rates
The Fed pivot facilitated major moves in the rates markets that could be expected coming out of a period of extremely accommodative central bank monetary policy. Similar to other periods of change, we believe clients are best served by re-evaluating the options to manage their cash more efficiently. This can often be achieved by synching investment objectives, risk parameters, and time horizon with the investments themselves. Taking a step back, it is important to spend a moment talking about investor psychology when interest rates are increasing. As we head into another rate hiking cycle, we understand that many investors will likely shift their focus to shorter duration strategies. While this type of tilt may favor MMFs and bank deposits, we often need to remind investors that what is important is to ensure cash and liquid assets are managed in an efficient manner, something that can lead to maximizing income and total return. As rates rise, duration can still be your friend but only if what happens with future interest rates is less than what is currently priced into the market.
A robust investment and risk management process can mitigate interest rate risk while meeting the overriding objectives of capital preservation and liquidity. This is highlighted by our approach to portfolio positioning in the Summer of 2021 when yields were at their lows and spreads were at their tightest levels. We responded to these market dynamics accordingly, with high levels of liquidity and short duration profiles until the market appropriately priced in rising rates. The changes in market expectations and year-end technicals caused credit spreads to widen, and we were well-positioned to deploy cash given our short duration profiles. Today we currently favor short-term fixed rate and longer floating-rate securities in our portfolios.
Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass.
Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass.
Key Investment Themes
Major changes are also in store for MMFs in 2022 as regulators worldwide attempt to improve the resiliency of prime funds, especially in times of market stress like we experienced in March 2020. In December, the SEC released the following policy recommendations:
- Minimum daily liquid asset requirements increased from 10% to 25%; weekly from 30% to 50%
- A removal of required and permissive liquidity fees and redemption gate provisions
- A swing pricing requirement for institutional prime and institutional tax-exempt money funds
- Amendments added to address the functioning of Government constant NAV MMFs should short-term interest rate policy ever be set at negative levels
The proposals are subject to a 60 day public comment period. While the industry is heartened to see the elimination of the current gates and fees regime, it is likely to use the comment period to push back hard on the mandatory swing pricing requirement. As proposed, swing pricing will likely alter prime funds in a manner that makes them somewhat unrecognizable and removes much of the utility valued by investors. Tracking the impending regulatory developments and planning for alternatives to prime funds is certain to take on more importance as we move through 2022.
The elements of societal change that Dylan expressed in the song and the need to heed the call also have parallels today as sustainable and socially responsible investing play an increasingly important role in treasury management. Whether investing to generate social change or to focus on strategies investing in companies making a more positive impact on environmental, social, and governance factors, treasury teams are looking to align their strategies with the broader corporate ethos. As a result, investors will look to their asset management partners to deliver new solutions that have a more direct and measurable diversity and inclusion impacts.
Adapting and adjusting to change brought about by the COVID-19 pandemic and the transition to work from home arrangements have also prompted a review of treasury systems and processes to ensure that they meet the continuous changes taking place today. Outdated and inefficient processes are being enhanced or replaced with tools including cloud-based solutions, APIs, and artificial intelligence providing assistance in cash flow forecasting, decision making, and developing more optimal cash management strategies. The inevitability of change will continue to drive innovation and advancements in technology, leading to opportunities for improved cash flow forecasting and visibility, optimal cash management, and more positive economics. There are also new opportunities to use investable cash balances to offset the cost of certain treasury tools and technology.
In Summary
“The line is drawn, as the present now, will later be past, for the times they are a-changin’.” The last stanza of Dylan’s song speaks to change, the continual nature of change and the need for preparation. Tapering is winding down and rate increases are on the horizon. Regulators are likely to change the rules in the money market space and cash managers are looking for increased efficiency in managing their assets. Investors will likely continue to focus on ways to make an impact with their capital that are aligned with their values.
While 2022 is shaping up to be a watershed year, also know that “present will soon be the past”.
As always, we at Morgan Stanley are here to help and work with you to manage and adjust to the times that are a-changin’.
Risk Considerations
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events.
Accordingly, you can lose money investing in these portfolios. Please be aware that these portfolios may be subject to certain additional risks and general market liquidity (market risk). Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. ESG Strategies that incorporate impact investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.
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Chief Investment Officer of Global Liquidity
Global Liquidity Team
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Executive Director
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Executive Director
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