Federal Reserve Board¹

The Federal Open Market Committee (FOMC) voted unanimously to increase the federal funds target range by 0.50% to a range of 0.75% to 1.00% at the conclusion of its May meeting, as expected. Additionally, the FOMC announced it will begin reducing its balance sheet on June 1, 2022. It will start by reducing $47.5 billion of Treasury securities, agency debt and agency mortgage-backed securities for the next three months, then increase it to $95 billion per month thereafter. Chairman Powell insisted that inflation was “much too high” and rate increases were needed “expeditiously.” He also downplayed the possibility of a 0.75% increase in the future but indicated another 0.50% hike was on the table at the June meeting.

European Central Bank¹

 At the European Central Bank’s (ECB) policy meeting on April 14, 2022, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The Governing Council announced it would cease purchases under its asset purchase programme (APP) in the third quarter. The ECB is managing a myriad of economic crosscurrents and the heightened uncertainty of the Russia-Ukraine war, and will continue its data-driven approach to guide inflation back to 2% over the medium term.

Bank of England¹

At its May meeting, the Bank of England (BoE) Monetary Policy Committee (MPC) voted 6-3 to increase the Bank Rate by 0.25% to 1.00% in response to elevated inflation. The three dissenting votes preferred a 0.50% increase. The BoE noted that recent inflation data exceeded expectations by about 1%, and it now projects peak inflation around 10%. The MPC believes that U.K. gross domestic product is likely to come in below expectations for the first half of the year as the price of energy and goods has soared. At its current pace, inflation is estimated to decline to the committee’s 2% target in two years.

PORTFOLIO STRATEGY

Prime Strategy³

Inflation continued to touch 40-year highs while Fed officials indicated their preference to front-load interest rate hikes. The market was pricing in an additional 10 interest rate hikes through the remainder of the year, with a 50 basis point increase anticipated at the May FOMC meeting (which did materialize). Amid expectations for an aggressive Fed in the near term, we continue with our strategy of remaining conservatively positioned, purchasing short-dated, fixed-rate securities and longer daily resetting SOFR floating-rate notes, allowing the portfolios to turn over quickly in each subsequent higher interest rate environment. As of month-end, the WAMs (weighted average maturity) of our portfolios remain near the lowest end of the peer group. We believe this is a preferable position as another 100 basis points of tightening are expected at the next two FOMC meetings. We remain comfortable managing the portfolios with elevated levels of liquid assets, ensuring that we uphold our mandates of capital preservation and liquidity.

Government/Treasury Strategy⁴

As the likelihood of multiple interest rate hikes by the FOMC continued to be priced into the front end of the curve, we continued to favor buying 6-month Treasury bills in the latter part of April, as these auctions stopped at 1.25% and 1.37%. Economic data during the month continued to support a more aggressive FOMC rate policy stance at its May meeting. As yields on fixed-rate Treasuries and agencies largely moved higher week-over-week, we sold some of our shorter fixed-rate positions to buy slightly further out in the curve to capture these higher yields. Any term repo maturities were rolled into either a very short, fixed-rate maturity near the May FOMC date or a longer floating-rate maturity indexed off SOFR. In our portfolios permitted to hold repos, we continue to hold large overnight repos that should reset to the new overnight repo rate the day following the FOMC meeting. We continue to expect more front-loaded rate hikes from the FOMC and believe our portfolio construction can benefit in that environment.

Tax-Exempt Strategy³

Municipal market losses in April were severe, bringing the year-to-date total return to near -9%, marking the Bloomberg Municipal Bond Index’s largest losses since its inception in the 1980s. The broader force of rising interest rates this year has overwhelmed technical forces like supply and reinvestment trends.

At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) decreased during the month of April as dealer inventories dropped to more manageable levels. The SIFMA Index,4 which measures yields for weekly VRDOs, declined 7 basis points to finish the month at 0.44%. At the longer end of the municipal money market maturity range, rates rose over the course of the month. The Bloomberg BVAL One-Year Note Index5 increased 42 basis points, finishing the month at 1.94%.

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.

⁴ 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.

⁵ The Bloomberg BVAL One-Year Note Index represents tax-exempt municipal bonds that have an average rating of AAA by Moody’s and S&P. “Bloomberg®” and the Bloomberg Index/Indices used are service marks of Bloomberg Finance L.P. and its affiliates, and have been licensed for use for certain purposes by Morgan Stanley Investment Management (MSIM). Bloomberg is not affiliated with MSIM, does not approve, endorse, review, or recommend any product, and does not guarantee the timeliness, accurateness, or completeness of any data or information relating to any product.

The views and opinions expressed are those of the Portfolio Management team as of April 30, 2022 and are subject to change based on market, economic and other conditions. Past performance is not indicative of future results.