June 17, 2021
Will Inflation Surprises Prompt Policy Shifts?
June 17, 2021
Federal Reserve Board1
Federal Reserve (Fed) Chairman Jerome Powell and the Federal Open Market Committee (FOMC) did not meet in May. Minutes from the April FOMC meeting indicated that officials were cautiously optimistic about the U.S. economic recovery, with some signaling that it would be appropriate to adjust the pace of their asset purchase program. The next meeting is set for June 16, 2021, where the Fed will release an updated summary of economic projections. Investors will want to pay attention to Chairman Powell’s forward guidance, as the U.S. has made significant vaccination progress and more businesses around the country have reopened to the public.
European Central Bank1
The European Central Bank (ECB) also did not hold a formal policy meeting in May. In the upcoming June meeting, analysts expect the ECB to leave policy and bond buying unchanged. Outside of policy, the ECB’s commentary on the vaccine rollout’s impact on economic data will be highly sought.
Bank of England1
The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and voted 8-1 to maintain its U.K. government bond purchase program at its May meeting. The MPC positively revised expected first quarter 2021 gross domestic product (GDP) growth to around -1.5%, which is “less weak” than originally anticipated. In addition, the committee revised up its second quarter and full year projections, citing declining COVID-19 case counts, vaccination progress and loosened restrictions on businesses within the U.K. In February, it projected economic activity to return to pre-pandemic levels next year. However, the May press release noted, “GDP is expected to recover strongly to pre- COVID levels over the remainder of this year in the absence of most restrictions on domestic economic activity.” While much more constructive and optimistic, the committee will continue to monitor economic data closely, standing “ready to take whatever additional action is necessary.”
Due to both fiscal and monetary stimulus, along with reductions at the Treasury General Account, the short end of the yield curve remains flush with cash, pushing spreads tighter month-over- -month. Three-month LIBOR4 continued to rally throughout the month, ending at another record low of 0.13138% on May 28. Our investment strategy remains consistent with prior months, with a preference to add fixed-rate investments to the portfolios, due to the liquidity and roll-down benefits of that structure, while also avoiding the reset risk associated with floating-rate notes. Weekly liquidity in our portfolios remains elevated, in excess of 50% throughout the month.
May marked significant inflows to government money market funds as fiscal stimulus payments and other cash filtered into our markets in large order. Given the extremely low single-digit yields in Treasury and agency debt and the lack of incremental dealer repo, investors placed cash in the Federal Reserve Bank of New York’s overnight reverse repo facility (RRP), which hit a new high of $485.329 billion. Throughout the month, volume in the RRP increased, peaking the day before month-end, exemplifying the excessive amount of cash in the front-end of the curve. In the portfolios, we invested incoming net inflows mainly in overnight repurchase agreements, including the RRP, given these market conditions and front-end yield compression. We continue to ensure high levels of liquidity and manage the portfolios to be responsive to changes in market conditions and interest rate levels.
At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) were little changed throughout the month of May. The SIFMA Index,6 which measures yields for weekly VRDOs, dropped 1 basis point, finishing the month at 0.05%. Yields at the longer end of the municipal money market maturity range were little changed while supply remained constrained. The Bloomberg BVAL One-Year Note Index7 finished the month at 0.09%, up 0.01% from the prior month-end.
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.