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June 17, 2021

Will Inflation Surprises Prompt Policy Shifts?

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June 17, 2021

Will Inflation Surprises Prompt Policy Shifts?


Market Insights

Will Inflation Surprises Prompt Policy Shifts?

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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.”

 
 
 
Display 1: Monthly Interest Rate Summary as of 5/31/21
 

Source: Bloomberg.

 
 
 
Display 2: Morgan Stanley Institutional Liquidity Funds (MSILF) Weighted Average Maturities (WAM) Summary2 as of 5/31/21
 

Source: iMoneyNet 

 
 

PORTFOLIO STRATEGY

PRIME STRATEGY3

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.

GOVERNMENT/TREASURY STRATEGY5

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.

TAX-EXEMPT STRATEGY3

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.

 
 

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 London Interbank Offered Rate (LIBOR) is the short-term interest rate that banks charge one another and that is generally representative of the most competitive and current cash rates available.

5 Government and Treasury Funds are Stable NAV funds.

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.

The views and opinions expressed are those of the Portfolio Management team as of May 31, 2021 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%.

The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment.

Past performance is no guarantee of future results. This document represents the views of the portfolio management team. The authors’ views are subject to change without notice to the recipients of this document. It does not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management and may not be reflected in other strategies and products that the Firm offers.

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.

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.

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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.

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Please be aware that liquidity instruments may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In the current rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest-rate environment, the portfolio may generate less income.

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