December 20, 2021
Fed Begins Tapering While BoE Defers Rate Hike
December 20, 2021
Federal Reserve Board1
The Federal Open Market Committee (FOMC) voted unanimously to keep the federal funds rate unchanged at a range of 0.00% to 0.25% at the conclusion of its November meeting. In line with market expectations, the Federal Reserve (Fed) announced it will start to taper its bond purchases in November. To start, the Fed will reduce purchases of Treasury securities by $10 billion and mortgage-backed securities by $5 billion per month. Purchases are anticipated to be reduced each month, but the committee “is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.” Additionally in November, Jerome Powell was reappointed as Federal Reserve chairman for a second term.
European Central Bank1
The European Central Bank (ECB) did not hold a formal policy meeting in November. However, investors will want to pay close attention to the ECB’s December meeting as inflation appears to be running hotter than the central bank’s projections earlier this year.
Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to maintain the Bank Rate at 0.10% and voted 6-3 in favor of leaving the size of its U.K. government bond purchase program unchanged at the conclusion of its November 4 meeting. The decision to hold rates steady came as a surprise to many as the MPC was expected to be first major central bank to shift interest rates higher since the pandemic started. The BoE cited uncertainty around the economic outlook as a main factor for leaving rates unchanged. Moving forward, the MPC signaled rate hikes were on the horizon, saying “it will be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.”
MSLF EURO LIQUIDITY FUND (LVNAV)
The euro yield curve is now completely inverted, as year-end pressures come to the fore. Government debt yields for January maturities are already through the -1% level and money market issuance is following this downward trend. A number of issuers have already dropped January/early 2022 maturities from their issuance levels, with the subsequent supply-demand imbalance pushing yields lower. Overnight levels have also been impacted and have fallen by several basis points over the month. Against this backdrop, tail-end bonds have continued to look attractive relative to money market instruments and we have continued to look for opportunities in this space, particularly for January maturities. Fund size largely remained between €10 billion and €10.5 billion during November, as clients started to place cash ahead of year-end. Meanwhile, the WAM (weighted average maturity) increased from 46 days to 49 days over the month, as we added duration in order to offset the impact of year-end yields.
MSLF STERLING LIQUIDITY FUND (LVNAV)
The Bank of England’s MPC defied market expectations at the November policy meeting, leaving rates unchanged following weeks of hawkish rhetoric. However, the sterling curve remains steep, which has been exacerbated by both the uncertainty around the December MPC meeting, as well as the year-end pricing pressures. Yields in overnight securities are trading at close to zero or slightly negative in repo, and despite the market pricing in a full 15 basis point rate hike for December, this has not been reflected in maturities short of 4 months (which have been trading in the low 10 basis points in terms of yield). The Fund size increased over the month, rising from just under £7.2 billion to over £7.6 billion. The WAM and WAL (weighted average life) also rose, as some of the inflows were used to term out the Fund, including taking advantage of attractive levels in secondary floating-rate note markets. We continue to look for further opportunities in this space.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
The Fed tapering its monthly purchase program is the crucial first step to clearing the way for potential interest rate increases in 2022. As a result of market expectations for the path of monetary policy in 2022, new issue offers in the commercial paper/certificates of deposit space in the 6- to 13-month tenors widened throughout the month. As the money market curve reprices with updated Fed expectations, we remain confident in our approach of remaining patient and waiting to deploy capital only after we feel we are being appropriately compensated for both interest rate and credit risk in the 2022 maturities. On the month we purchased both fixed- and floating-rate securities, with fixed tenors in the first half of 2022 and floating-rate securities with maturities in the second half of 2022, that reset off the SOFR index with coupons that will immediately reprice in the event the Fed hikes rates. Our portfolio ended the month with both WAM and WAL on the lower end of the peer group, with weekly liquidity in excess of 60%.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
During the month, there was no progress on a resolution to the debt ceiling. Treasury bills maturing in late December cheapened as investors priced this area as the new potential technical default zone, i.e., when the Treasury could run out of cash. While not reflected in market pricing, some participants believe the government’s cash balances could last through January. We remain vigilant of the recurring limit debate and think Congress is likely to address the debt limit before its December recess. While market expectations grew for a potentially sooner rate hike next year, the short Treasury curve has barely moved higher given the level of excess cash in the market. The 6-month and beyond segment of the curve cheapened, but short rates remained largely unchanged. We continued 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.