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October 20, 2023

Approaching the Summit

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October 20, 2023

Approaching the Summit


Market Insights

Approaching the Summit

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October 20, 2023

 
 

Federal Reserve Board1
After the Federal Open Market Committee (FOMC) increased the federal funds target rate by 0.25% to a range of 5.25% to 5.50% in July, the committee observed incoming data in August and decided to leave rates unchanged at the conclusion of its September meeting. The press release was relatively unchanged aside from a minor adjustment in characterizing the economic expansion as “solid,” from “moderate” previously. The release also noted that while job growth “remains strong” it has more recently “slowed.”The September meeting included an update of the Fed’s summary of economic projections. The Fed’s dot plot showed officials’ median projection for the benchmark rate at the end of 2023 was unchanged at 5.6%. The 2023 median gross domestic product (GDP) growth projection was increased substantially 110 basis points to 2.1%. The 2024 GDP growth forecast improved as well to 1.5%. The 2023 unemployment rate estimate declined 30 basis points to 3.8%. The Fed increased its median 2023 personal consumption expenditure (PCE) inflation forecast to 3.3% in September from 3.2% in June. The 2024 PCE projection was unchanged at 2.5%. 

European Central Bank1
At the European Central Bank’s (ECB) policy meeting on September 14, President Lagarde and the policy committee increased the ECB deposit rate by 0.25% to 4.00%. The ECB noted that inflation has continued to decline, but remains too high. The committee hinted at rates potentially peaking, stating, “the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” While committee members reduced their economic growth projections, they remain “determined” to reduce inflation to the 2% target.

Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 5-4 to hold the Bank Rate steady at 5.25% at the conclusion of its September meeting. Four dissenting members preferred to increase the rate 0.25% to 5.50%. In addition, the MPC voted unanimously to shrink the stock of U.K. government bonds by £100 billion during the next 12 months. BoE members noted the labor market continues to show further signs of “loosening,” although it currently remains “tight by historical standards.” The August 12-month inflation data came in 0.4% below expectations, at 6.7%. MPC members remain committed to reducing inflation, noting policy “will need to be sufficiently restrictive for sufficiently long” to ensure its remit is accomplished.

 
 
 
Display 1: Monthly Interest Rate Summary as of 9/30/23.
 

Source: Bloomberg

 
 
 
Display 2: Morgan Stanley Institutional Liquidity Funds (MSILF) Weighted Average Maturities (WAM) Summary2
 

Source: iMoneyNet 

 
 

PORTFOLIO STRATEGY

GOVERNMENT/TREASURY STRATEGY
We increased WAM in the month via additions of Treasury bills and agency discount notes (where eligible) around the 5.50% context, as we believe the Fed is likely either done or very close to done with this hiking cycle. We believe attractive interim carry profiles and the possibility that an additional rate hike may not come for several more months make these trades worthwhile. We seek to continue to add tactically as we work through upcoming data.

FOMC speakers have expressed a growing comfort with the current level of restrictive rates, at least for the time being, as they wrestle with changing data and geopolitical risks. While still cautious on a potential resurgence in inflation, the Fed wants to give the economy some time to let the rapid pace of hikes take effect. We see an increasing likelihood that the Fed will embark on a lengthy holding pattern, with the possibility of intermittently hiking rates as needed to calibrate and fine-tune policy in response to incoming data. Supply continues to be a tailwind to Treasury yields—it will be interesting to see how this plays out in the last quarter of the year.

Supply remains elevated, and another round of T-bill supply increases is likely to take place in October. So far, this supply has been taken down quite well by the yield-seeking community of front-end investors. As the market attempts to price more rate cuts out of the near future, we believe 6-month and 1-year bills have started to become more attractive. Currently, we have no concerns or issues to raise with respect to T-bill liquidity.

PRIME STRATEGY3
With the futures market priced mostly in line with updated Fed projections from the September FOMC meeting, indicating a 50% chance of another rate hike by the December FOMC meeting and a hold thereafter, we opportunistically added duration in the 6- to 9-month tenors. We locked in attractive carry while also being compensated for the likelihood of an additional rate hike later this year. We continue to hold floating-rate note exposure through the remainder of 2023 and into early 2024, seeking to diminish the portfolio’s sensitivity to interest rate risk if the Fed hikes again or needs to reach a higher-than-expected terminal rate. The portfolio’s maturity profile, WAM and WAL, ended the period toward the median of the peer group.

Liquidity remains strong, and dealer balance sheets remain unconstrained as spreads have held mostly static over the past couple months. As we enter the likely final stages of this tightening cycle, we remain thoughtful about security selection, seeking to ensure we are purchasing the most liquid securities in the appropriate formats, while opportunistically adding duration when there is a dislocation in market pricing.

TAX-EXEMPT STRATEGY
The Bloomberg Municipal Short-Term Index4 posted a +0.08% return for the month of September 2023, continuing its outperformance versus the broader municipal market. The Bloomberg U.S. Municipal Bond Index5 returned -2.93% for the month. Given the Federal Open Market Committee’s hawkish pause on September 20—which maintained its 5.25%-5.50% federal funds target range and signaled another possible hike this year with the statement, “the extent of additional policy firming that may be appropriate”—we continue to favor shorter WAM/WAL in anticipation of higher municipal money market rates. The SIFMA Index,6 which measures yields for weekly variable rate demand obligations (VRDOs), continued to see volatility, moving as high as 4.31% intra-month then ultimately closing the month at 3.98%.

 
 

1 Source: Bloomberg.

2 Weighted Average Maturity (WAM): Measures the weighted average of the maturities of the portfolio’s individual holdings, taking into account reset dates for floating rate securities.

3 The Portfolio will be required to price and transact in their shares at a floating net asset value (“NAV”) and will be permitted to impose a liquidity fee on redemptions or temporarily restrict redemptions in the event that the Portfolio’s weekly liquid assets fall below certain thresholds.

4Bloomberg U.S. Municipal Bond Index is an index that covers the USD-denominated long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds.

5 The Bloomberg U.S. Municipal Bond Index is an index that covers the USD-denominated long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. It is composed of approximately 1,100 bonds.

6 The SIFMA Municipal Swap index is a 7-day high-grade market index comprised of tax-exempt VRDOs reset rates that are reported to the Municipal Securities Rule Making Board’s (MSRB’s) SHORT reporting system.

The views and opinions expressed are those of the Portfolio Management team as of September 30, 2023 and are subject to change based on market, economic and other conditions. Past performance is not indicative of future results.

 

 
 
 
The Global Liquidity team aims to effectively meet clients’ unique cash and working capital needs, offering a broad range of money market funds, ultra short bond funds and customized separate account solutions.
 
 
 
 
 

One basis point = 0.01%

The Bloomberg U.S. Municipal Bond Index is an index that covers the USD-denominated long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. It is composed of approximately 1,100 bonds.

The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment.

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Please be aware that liquidity instruments may be subject to certain additional risks. 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 the current rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest-rate environment, the portfolio may generate less income.

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