Federal Reserve Board¹

The Federal Open Market Committee (FOMC) voted 8-1 to increase the federal funds target range by 0.25% to a range of 0.25% to 0.50% at the conclusion of its March meeting. James Bullard was the only member voting against the 0.25% increase as he preferred an increase of 0.50%. The Federal Reserve (Fed) noted that the Russia-Ukraine conflict is likely to cause “additional upward pressure” on inflation and weigh on gross domestic product (GDP). The FOMC believes job growth and economic activity “continue to strengthen,” but acknowledge inflation is too high.

The March 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 2022 is approximately 1.9%, and then is expected to rise to approximately 2.5% in 2023. The 2022 median GDP growth projection was downgraded to 2.8% in March from 4.0% in December. The 2023 and 2024 GDP growth forecasts remain unchanged at 2.2% and 2.0%, respectively. The 2022 and 2023 unemployment rate estimates were unchanged in March from December. The Fed increased its median 2022 personal consumption expenditure (PCE) inflation forecast to 4.3% currently from 2.6% in December. The 2023 PCE forecast was also increased, to 2.7% from 2.3%.

European Central Bank¹

At the European Central Bank’s (ECB) policy meeting on March 10, 2022, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The Governing Council announced the asset purchase programme (APP) purchase schedule for the second quarter, as the program winds down. Net purchases under the program will amount to “€40 billion in April, €30 billion in May and €20 billion in June.” The ECB is committed to a data-driven approach, with purchases under the APP likely to cease in the third quarter if inflation expectations do not weaken.

Bank of England¹

The Bank of England (BoE) Monetary Policy Committee (MPC) voted 8-1 to increase the Bank Rate by 0.25% to 0.75% in response to elevated inflation at its March meeting. The one dissenting vote preferred to keep the Bank Rate at 0.50%. The BoE believes peak inflation is likely to be higher than its February forecasts, but noted January GDP was stronger than anticipated. The Bank suggested the Russia-Ukraine conflict has caused higher energy and commodity prices. Against a backdrop of persistently high inflation, global supply chain concerns and a weakening outlook, the BoE also acknowledged the strength and resiliency in business confidence and the job market in the first two months of the year.

PORTFOLIO STRATEGY

Prime Strategy³

While Fed dot plot projections were in line with market pricing, they were higher than previously anticipated and affirmed the market’s expectations of an aggressive Fed who plans on tackling inflation by increasing the fed funds rate. After additional hawkish messaging from Fed officials following the FOMC meeting, the market closed the quarter with another eight rate hikes expected for the 2022 and a 2-year Treasury setting of 2.33%, a new recent high. As inflation continues to set at 40-year highs with an upward bias in the near term and a hawkish Fed likely to raise rates aggressively at upcoming FOMC meetings, we purchased short fixed-rate securities and longer-dated daily resetting SOFR floating rate notes throughout the month, which contributed to the WAMs (weighted average maturity) of our portfolios to end the reporting period on the lower end of the peer group. We remain comfortable managing the portfolios with elevated levels of liquid assets, seeking to uphold our mandates of capital preservation and liquidity.

Government/Treasury Strategy⁴

After the 25 basis point rate hike by the FOMC in March, overnight dealer repo rates moved in line as expected to 30 basis points. Yields in Treasuries and agencies continued to move progressively higher during the month, especially towards month-end, as the likelihood of a 50 basis point hike increased at the next FOMC meeting (in May) to combat inflation. We marginally extended into fixed-rate Treasuries and also bought agency and Treasury floating-rate notes to benefit from the expected movement in market yields. We continued to hold a large allocation to overnight repurchase agreements, which benefited the following day from higher repo rates. We continue to expect more front-loaded rate hikes from the FOMC and believe our portfolio construction is likely to benefit in that environment.

TAX-EXEMPT STRATEGY³

The first quarter was the municipal bond market’s worst quarter in about 40 years with a -6.4% loss as measured by the Bloomberg Municipal Bond Index, a dramatic pullback for an asset class that investors favor for its stability. The loss so far this year is in line with bonds globally as central banks increase interest rates to combat the fastest inflation in decades. Uncertainty around the Federal Reserve, the Treasury market and the geopolitical landscape will likely continue to weigh on the market.

At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) increased during the month of March as dealer inventories rose significantly. The SIFMA Index,⁴ which measures yields for weekly VRDOs, increased 31 basis points to finish the month at 0.51%. At the longer end of the municipal money market maturity range, yields also rose over the course of the month. The Bloomberg BVAL One-Year Note Index⁵ increased 71 basis points finishing the month at 1.52%.

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 March 31, 2022 and are subject to change based on market, economic and other conditions. Past performance is not indicative of future results.