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March 15, 2022

Inflation Starts to Push Central Banks’ Accommodative Hand

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March 15, 2022

Inflation Starts to Push Central Banks’ Accommodative Hand


Market Insights

Inflation Starts to Push Central Banks’ Accommodative Hand

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March 15, 2022

 
 

Federal Reserve Board1

Federal Reserve (Fed) Chairman Jerome Powell and the Federal Open Market Committee (FOMC) did not meet in February. Minutes from the January FOMC meeting indicated that officials were concerned about the longer-term impacts to financial stability with continued accommodative monetary policy. Participants expressed that if inflation were to persist it’s likely “appropriate” to tighten monetary policy at a “faster pace” than anticipated. Some members believe reducing the balance sheet will also be “appropriate” this year. Fed speak throughout February suggests that committee members are coalescing around raising interest rates 25 basis points at the March meeting.

European Central Bank1

At the European Central Bank’s (ECB) policy meeting on February 3, 2022, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The Governing Council will conduct asset purchases at reduced pace under its pandemic emergency purchase programme (PEPP) in the first quarter. Furthermore, the ECB will halt asset purchases under PEPP at the end of March 2022. While President Lagarde acknowledged higher inflation risks in the near term and declined to rule out a possible rate hike in 2022, officials confirmed their forward guidance, saying interest rates will remain at current levels until “progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term.”

Bank of England1

The Bank of England (BoE) Monetary Policy Committee (MPC) voted 5-4 to increase the Bank Rate 0.25% to 0.50% in response to elevated inflation. The four dissenting votes preferred to increase the Bank Rate 0.50% to 0.75%. The MPC unanimously voted to leave the size of its U.K. government bond purchase program unchanged at the conclusion of its February 3 meeting. The BoE increased its peak inflation forecast to 7.25% in the first half of 2022. The committee believes that upward pressure on inflation will likely fade “over time” as supply chain issues ease and prices of goods decline from historically elevated levels.

 
 
 
Monthly Interest Rate Summary as of 2/28/22
 

Source: Bloomberg

 
 
 
MSILF Weighted Average Maturities (WAM) Summary as of 2/28/22
 

Source: iMoneyNet 

 
 

PORTFOLIO STRATEGY

Prime Strategy3

Following the FOMC’s January meeting minutes release suggesting a possible faster pace of rate hikes, and with inflation setting at 40-year highs the week prior, Treasuries sold off with the 2-year note touching a recent high of 1.60% on February 23. In the days following, heightened geopolitical concerns in eastern Europe due to the Russia-Ukraine conflict and the subsequent response mechanisms enacted by the West caused the market to back off their pricing of expected rate hikes in 2022, ending the month with slightly under five hikes anticipated, and an increase of only 25 basis points expected at the upcoming March FOMC meeting. With heightened risk in the market, we remain comfortable running our portfolios with elevated levels of weekly liquidity, setting above 50% throughout the month.

Government/Treasury Strategy4

Treasury and agency yields cheapened as the month progressed, as market expectations held up for multiple rate hikes by the FOMC this year. Toward the latter part of February, as yields rose, we bought Treasuries across the curve, selecting maturities deemed appropriately priced for our rate hike expectations. These purchases extended portfolio durations by approximately 7 to 10 days, which we considered appropriate as the possibility of a 50-basis point rate hike in March diminished given growing geopolitical risks from the Russia-Ukraine conflict. We bought fixed-rate Treasuries with some floating-rate agencies indexed off SOFR. We continued to hold a significant allocation to overnight repurchase agreements, which also helps us to be proactive and responsive to changes in market conditions and interest rate levels.

TAX-EXEMPT STRATEGY3

Treasury yields experienced significant volatility during the latter part of February as the Russia-Ukraine conflict prompted markets to reassess expectations on Fed rate hikes this year. Investors continued to withdraw from municipal bond mutual funds throughout the month, with outflows of $11.8 billion from muni funds year-to-date.5

At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) increased during the month of February as dealer inventories rose. The SIFMA Index,6 which measures yields for weekly VRDOs, increased 14 basis points to finish the month at 0.20%. The longer end of the municipal money market maturity range also rose over the course of the month. The Bloomberg BVAL One-Year Note Index7 increased 15 basis points, finishing the month at 0.81%.

 
 

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 Source: Morgan Stanley Investment Management. As of February 28, 2022.

5 Source: Lipper, as of February 28, 2022.

6 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.

7 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 February 28, 2022 and are subject to change based on market, economic and other conditions. Past performance is not indicative of future results.


 
 
 
The Global Liquidity team aims to effectively meet clients’ unique cash and working capital needs, offering a broad range of money market funds, ultra short bond funds and customized separate account solutions.
 
 
 
 
 

One basis point = 0.01%

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