May 12, 2020
Central Banks Continue to Pledge Support to the Economy
May 12, 2020
Federal Reserve Board1
The Federal Open Market Committee (FOMC) decided to keep the target range for the federal funds rate unchanged at 0.00% - 0.25% at its scheduled meeting on April 29, 2020. This was the first meeting since tangible economic data had been collected on the coronavirus impact. The committee noted that the virus had catalyzed significant job losses and steep drawdowns in both consumer spending and consumer confidence. In March, the Federal Reserve (Fed) acted swiftly to respond to the potential impacts of COVID-19 by lowering rates to the lower bound while also implementing quantitative easing (QE) programs, among other facilities aimed at increasing liquidity in short-term debt markets.
In April, fears of potential coronavirus impacts were realized. First quarter gross domestic product (GDP) growth came in at -4.8% and initial jobless claims surged to around 30 million. While extraordinarily weak readings were anticipated as a result of the temporary pause across many parts of the economy, both data points underperformed expectations. Chairman Powell noted in his press conference that the current policy was appropriate while acknowledging that “the ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” The chairman also noted that the committee will “maintain this target range until it is confident that the economy has weathered recent events.”
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on April 30, 2020, President Lagarde and the policy committee kept the ECB deposit rate unchanged at -0.50%. However, the ECB eased conditions on its targeted longerterm refinancing operations (TLTRO III) by lowering the rate to "50 basis points below the average interest rate of the Eurosystem’s main refinancing operations." The ECB will continue to conduct stimulus by maintaining its Pandemic Emergency Purchase Program (PEPP) as announced in March. The ECB noted in its press release that "these purchases will continue to be conducted in a flexible manner over time, across asset classes and among jurisdictions. The Governing Council will conduct net asset purchases under the PEPP until it judges that the coronavirus crisis phase is over, but in any case until the end of this year." At the press conference, President Lagarde said the ECB expects euro area GDP to contract between 5% and 12% in 2020.
Bank of England1
Although no formal policy meeting was held in April, market participants and analysts expect the Bank of England (BOE) to further ease and/ or increase stimulative policy. The BOE’s next meeting on May 7, 2020 is highly anticipated, considering the unprecedented policy actions taken by other central banks around the world.
DISPLAY 2: Morgan Stanley Institutional Liquidity Funds (MSILF) Weighted Average Maturities (WAM)2
Funding conditions improved throughout the month of April, with 3-month LIBOR rallying from 1.45% on March 31 to 0.56% on April 30. With the Fed indicating that it is “committed to using its full range of tools to support the U.S. economy,” while also pledging to keep rates near zero in the near term, the market is pricing in no changes to the benchmark policy rate until 2022. As assets return to Prime funds, we opportunistically extended the duration of the portfolios by purchasing longerdated fixed-rate securities, ending the month with the weighted average maturities (WAMs) of the funds in excess of 50 days. Going forward, we remain comfortable managing the portfolios with elevated levels of liquid assets, seeking to ensure that we uphold our mandates of capital preservation and liquidity.
In April, a massive issuance of Treasury bills hit the market to help the U.S. government fund ongoing stimulus and other aid packages. The record supply moved front-end Treasury yields higher, where the bill supply was concentrated. However, strong investor demand for short bills tempered some of the yield increase and flattened the short Treasury curve. While fund inflows moderated from the prior month, we continued to have strong industry inflows to government and Treasury money market funds, which contributed to this demand. We bought Treasury bills across our portfolios, reducing the amount of overnight repo, as repo rates remain pegged at low single digits. We also bought longer-term agency floating-rate notes where spreads remained attractive.
We continue to seek to ensure high levels of liquidity and manage the portfolios to be responsive to changes in market conditions and interest rate levels.
The primary market began seeing supply gradually return to normal levels by April month-end, as yields became more enticing for issuers. The SIFMA Index5 of weekly variable rate securities continued to drop, falling 161 basis points from 1.83% at the start of the month to 0.22% on April 29. Protecting the safety and liquidity of the portfolios’ assets remained our first priority. In the recent turbulent markets, our emphasis has been on managing liquidity and exposure to sectors and issuers that may come under stress as a result of a prolonged economic slowdown caused by the global pandemic. We continue to invest in tax-exempt securities, including variable rate demand obligations (VRDOs), where our credit and risk teams have confidence in the quality of the issuer, the structure of the program and the financial strength of the supporting institutions. We will also continue to closely monitor the implications of the slowing economy on municipal government balance sheets.