August 04, 2021
Central Banks Upgrade Economic Projections and Remain Accommodative
August 04, 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.”
MSLF EURO LIQUIDITY FUND (LVNAV)
Yield curves in euros continue to challenge, with excess liquidity at €4.2 trillion dampening wholesale funding needs. We are again facing a market where the premium to invest beyond overnight is limited until around 6 months in duration. However, in recent weeks 6-month levels have begun to drop towards overnight, further flattening the curve. The Fund saw inflows early in June and these were spent in 1-month maturities, adding to our liquidity over the half year-end period when balance sheet capacity issues put pressure on overnight levels. By the middle of the month the Fund had reached €9.4 billion in asset size, helping to maintain weekly liquidity at over 40%. Most of this was held in maturing assets, as sovereign, supranational and agency names have become increasingly expensive. Flows were more volatile in the second half of June, with the Fund ending the month at €8.9 billion in assets. Recently, tail-end bonds have been slightly harder to source, although we are still taking the opportunity to replace maturities in this space when we can.
MSLF STERLING LIQUIDITY FUND (LVNAV)
The sterling curve continued to offer up opportunities to invest in higher yields in early June, particularly in certain French and Japanese names. However, as half year-end approached, some of this supply dissipated. The Fund continued to gain assets during the month, increasing from £6.3 billion to finish June at around £7.2 billion in assets, having touched an all-time high of circa £7.6 billion on 15 June. The positive flows allowed us to add 3- to 6-month money market assets, yielding 5 to 8 bps more than overnight levels. This was complemented by tail-end bonds in fixed and floating formats, although we have exhausted most of the options here at the moment. The WAM increased from 48 to 54 days over the month, as the inflows were used to lengthen the Fund, although the lack of supply in floating-rate notes limited the amount of credit exposure we were able to take on. The inflows also helped keep weekly liquidity in the mid to high 40% range, complemented by adding treasury bills at attractive levels via the auction.
MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)
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. LIBOR 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 SOFR floating-rate note exposure has been beneficial to our portfolio as their coupons reset higher immediately after the technical adjustments announced at the June FOMC. Weekly liquidity in our portfolio remained elevated, in excess of 50% throughout the month.
MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)
After the June FOMC meeting, overnight repo rates largely moved higher to 5 basis points, in line with the adjustment increase. The yield curve flattened as front-end U.S. Treasury yields increased and one-year yields held steady at around 0.07%. In the portfolio, we extended the duration after the FOMC meeting by purchasing Treasury bills, favoring 6-month tenors, and continued to hold a significant amount of cash in overnight repurchase agreements collateralized by U.S. Treasuries. We continue to ensure high levels of liquidity and 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.