August 22, 2022
To Neutral and Beyond
August 22, 2022
Federal Reserve Board1
The Federal Open Market Committee (FOMC) voted unanimously to increase the federal funds target range by 0.75% to a range of 2.25% to 2.50% at the conclusion of its July meeting, as expected. The Federal Reserve (Fed) noted it worked expeditiously to get policy rates back to a “neutral” setting (generally considered to be around 2.50%). The Fed also expressed that future rate increases are appropriate. Regarding economic conditions, the committee downgraded its outlook saying, “recent indicators of spending and production have softened” and that the housing sector had weakened. Consistent with prior meetings, the FOMC continues to view inflation as “elevated” while job growth remains “robust.”
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on July 21, 2022, President Lagarde and the policy committee increased the ECB deposit rate by 0.50% to 0.00%, surprising investors with the magnitude of the increase. In June, President Lagarde had committed to increase the deposit rate by 0.25%, which many expected to materialize. But in the July meeting, the Governing Council felt it was “appropriate” to take a “larger first step” than previously signaled. It also approved the Transmission Protection Instrument (TPI), which can be activated to “counter unwarranted, disorderly market dynamics that pose a serious threat” to monetary policy in the euro area. Moving forward, the ECB will continue monitoring the data but is unlikely to explicitly state forward guidance.
Bank of England1
Although no formal policy meeting was held in July, analysts expect the Bank of England to increase rates by a potentially historic amount in August. The Bank of England is paying close attention to inflation data, which has significantly exceeded expectations and its 2% target.
With expectations that the Fed will continue to tighten monetary policy in the near term and the market pricing in another 100 basis points of tightening through the remainder of 2022, we remain comfortable managing the portfolios with elevated levels of liquidity and a short duration profile. Allocations to daily resetting SOFR and OBFR floating-rate notes continue to benefit the portfolios as their coupons reprice immediately following each rate hike.
We have kept the durations in portfolios that can do repurchase agreements on the shorter WAM side due to the nearly immediate yield benefit of higher repo rates following a FOMC meeting after a hike. The Fed’s reverse repo facility hit $2.3 trillion on July month-end, the second highest on record, and expectations are for it to likely continue to climb. We feel our portfolio construction allows us to be proactive and responsive to changes in market conditions and interest rate levels.
Our portfolio is well positioned for a rising rate environment, being short duration with high concentrations in variable rate demand obligations (VRDOs). At the short end of the municipal curve, yields for VRDOs rose during the month of July, driven higher by Fed rate expectations. The SIFMA Index,4 which measures yields for weekly VRDOs, increased 42 basis points to finish the month at 1.33%. Shorter durations were more heavily favored in July as buyers take a wait-and-see approach during the tightening cycle.
One basis point = 0.01%
The Bloomberg U.S. Municipal Bond Index is an index that covers the USD-denominated long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. It is composed of approximately 1,100 bonds.
The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment.
The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively the Firm”) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.
Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.
This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.
This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.
Charts and graphs provided herein are for illustrative purposes only. Past performance is no guarantee of future results.
The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.
This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a research material or a recommendation. Current and future portfolio holdings are subject to change. The forecasts in this piece are not necessarily those of Morgan Stanley, and may not actually come to pass.
Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness.
Please consider the investment objectives, risks, charges and expenses of the portfolios carefully before investing. The prospectus contains this and other information about the portfolios. To obtain a prospectus, download one at www.morganstanley.com/liquidity or call 1.800.236.0992. Please read the prospectus carefully before investing.
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events.
STABLE NAV FUNDS
You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Funds’ sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.
FLOATING NAV FUNDS
You could lose money by investing in the Fund. Because the share price of the Fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Funds’ sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.
The Tax-Exempt Portfolio may invest a portion of its total assets in bonds that may subject certain investors to the federal Alternative Minimum Tax (AMT). Investors should consult their tax adviser for further information on tax implications.
Morgan Stanley Investment Management is the asset management division of Morgan Stanley.
NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A BANK DEPOSIT