July 20, 2021
Central Banks Upgrade Economic Projections and Remain Accommodative
July 20, 2021
Federal Reserve Board1
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 June meeting as expected. While the Federal Reserve (Fed) did not tweak its forward guidance or quantitative easing policies, it did make a technical adjustment to rates. The FOMC boosted the rate on its overnight reverse repurchase (RRP) agreement facility by 5 basis points to 0.05%, and increased the interest paid on excess reserves by 5 basis points to 0.15% to foster smoother funding in the money markets. The statement positively tweaked language regarding vaccinations and the economy, saying, “progress on vaccinations has reduced the spread of COVID-19 in the United States. Amid this progress and strong policy support, indicators of economic activity and employment have strengthened.”
In addition to the press release, the Fed updated its summary of economic projections. The main modification to the FOMC’s projections occurred in 2023 dot plot. Thirteen of the 18 voting members expect two rate hikes in 2023, as of June, compared to the March projections showing only 7 of 18 voting members expecting a rate liftoff. The six additional votes for a rate hike in 2023 was a surprise; market consensus anticipated only two additional rate hike voters in 2023. The FOMC upgraded its real gross domestic product (GDP) forecast to 7.0% in 2021 from 6.5% in March. Unemployment rate projections were roughly unchanged from March. The committee estimates core Personal Consumption Expenditures to rise to 3% in 2021, but ultimately level out around 2% over the course of 2022 and 2023.
Although the Fed upgraded its language and economic forecasts, it continues to stand by the economy in case expectations are mired by the ongoing COVID-19 pandemic or projections don’t materialize.
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on June 10, 2021, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The committee kept the size of the pandemic emergency purchase program (PEPP) and asset purchase program unchanged in June. Although the ECB upgraded GDP and inflation projections for 2021 and 2022, the Governing Council noted it “stands 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 England1
The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and the size of its U.K. government bond purchase program at the conclusion of its June 24, 2021 meeting. The MPC noted the higher-than-expected U.K. GDP in May has increased “expectations for the level of U.K. GDP in the second quarter of 2021 by around 1.5% since the May Report.” The committee also acknowledged higher-than-expected consumer price index inflation in May. Although expectations have been positively revised, the MPC views current policy as appropriate and will continue to “monitor the situation closely.”
After the Fed increased its administered rates at the June FOMC meeting, the money market curve adjusted 3 to 4 basis points higher in the following days. LIBOR4 also retreated from all-time lows on June 14 of 0.118% to close the quarter at 0.14575%. While our preference remains for fixed-rate securities due to their liquidity and roll-down benefits, recent increases in SOFR5 floating-rate note exposure have been beneficial to our portfolios as their coupons reset higher immediately after the technical adjustments announced at the June FOMC. Weekly liquidity in our portfolios remain elevated, in excess of 50% throughout the month.
After the June FOMC meeting, overnight repo rates largely moved higher to 5 basis points, in line with the Fed’s technical adjustment increase. The yield curve flattened as front-end Treasury yields increased and one-year yields held steady at around 0.07%. After the adjustment, the RRP volume increased dramatically as the new 0.05% rate was an immediate improvement over other investment options. At month-end, the RRP volume hit an all-time high of $991.9 billion, underscoring the excessive cash levels versus attractive investment options for short-end investors. In the portfolios, we extended durations after the FOMC meeting by purchasing Treasury bills, favoring 6-month tenors. We continued to invest a significant amount of cash in overnight repurchase agreements and to manage the portfolios to be responsive to changes in market conditions and interest rate levels.
At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) were unchanged throughout the month of June. The SIFMA Index,7 which measures yields for weekly VRDOs, held steady at 0.03%. Yields at the longer end of the municipal money market maturity range were little changed as well, as supply remained constrained. The Bloomberg BVAL One-Year Note Index8 finished the month at 0.14%, up 0.05% from the prior month-end. The short-term tax-exempt market is expecting to see good demand throughout the next month as the July coupon payment inflows peak and maturities outweigh new issue supply.