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October 25, 2021

Taper Talk

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October 25, 2021

Taper Talk


Market Insights

Taper Talk

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October 25, 2021

 
 

Federal Reserve Board1

As expected, the Federal Open Market Committee (FOMC) kept the range for the federal funds rate unchanged at 0.00% to 0.25% at the conclusion of its September meeting. While the Federal Reserve (Fed) did not tweak its forward guidance or quantitative easing policies, it did reinforce Chairman Powell’s statements from the Jackson Hole Economic Symposium. Of note, the Fed increased the reverse repurchase (RRP) counterparty limit from $80 billion to $160 billion and signaled that a moderation of their monthly asset purchase program “may soon be warranted.” While Chairman Powell acknowledged that persistent supply bottlenecks are contributing to higher inflation expectations, the Fed maintained its view that the recent inflation pressures are transitory, slightly modifying its press release to read “inflation is elevated, largely reflecting transitory factors.”

The September meeting included an update of the Fed’s summary of economic projections. The 2022 “dot plot” now shows that half of the 18 voting members believe a rate hike is appropriate in 2022, an increase from seven members in the June projection. Only one voting member does not forecast a rate hike in 2023, while 17 out of the 18 voting members expect rates to move above the lower bound. The median expectation for the fed funds rate is 1.0% at the end of 2023. The FOMC added a new data point for 2024, where the median expectation is 1.8% at the end of 2024. The FOMC downgraded its 2021 real gross domestic product (GDP) forecast to 5.9% from 7.0% estimated in June. The downgrade in GDP can be attributed to rising COVID-19 case counts from the delta variant. Additionally, the Committee increased its inflation projections to 4.2% for 2021, up from its June forecast of 3.4%, for personal consumption expenditures (PCE). In addition, it estimates core PCE rising to 3.7% for 2021, higher than the 3.0% forecast in June, but ultimately leveling out marginally above 2% in the years following.

While the Fed downgraded projections for some metrics, it is unlikely to change their expected tapering timeline, barring a substantial surprise in equity markets or non-farm payrolls.

European Central Bank1

At the European Central Bank’s (ECB) policy meeting on September 9, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected. The committee kept the size of the pandemic emergency purchase program (PEPP) and asset purchase program unchanged. However, the ECB decided to reduce the pace of purchases under the PEPP in response to elevated inflation levels. The release noted, “Governing Council judges that favorable financing conditions can be maintained with a moderately lower pace of net asset purchases under the PEPP than in the previous two quarters.” It will conduct asset purchases with the same flexibility at a reduced pace while ensuring financial conditions remain accommodative and does not risk the economic recovery. The ECB also pointed out it is not required to deploy all the capital within the PEPP. The Governing Council will continue to monitor all incoming data and adjust policy as necessary to stabilize inflation at 2%.

Bank of England1

The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and voted 7-2 in favor of leaving the size of its U.K. government bond purchase program unchanged at the conclusion of its September 23 meeting. Similar to the Federal Reserve, the MPC noted signs of slowing growth against the backdrop of rising COVID-19 case counts and supply constraints. It revised down its third quarter GDP targets by nearly 1.00% since its last report (August). Overall, there is a greater sense of uncertainty from the Bank of England regarding the outlook, which suggests to us officials are adopting a wait-and-see approach.

 
 
 
DISPLAY 1: Overnight Rates
 

Source: Bloomberg

 
 
DISPLAY 2: LIBOR Rates
 

Source: Bloomberg

 
 
DISPLAY 3: Yield Curves
 

Source: Bloomberg

 
 

PORTFOLIO STRATEGY

MSLF EURO LIQUIDITY FUND (LVNAV)

The flattening/inversion of the euro yield curve is now well established and term rates are almost flat from overnight out to 6-months. The European Central Bank’s dovish new forward guidance, as well as the scale of excess liquidity in the system, has done little to abate this. We have seen our overnight deposit levels being reduced by some counterparties, further reducing our capacity. In the run up to quarter-end we reduced our overnight exposure, targeting maturities just beyond both the quarter-end and year-end periods. Tail end bonds have continued to look attractive relative to money market instruments, and we have continued to look for opportunities in this space, particularly for January maturities. These assets were complemented with short-dated commercial paper, which provided a yield pick-up over overnight securities. Fund size was relatively unchanged over the month, increasing from circa €9.6 billion to €9.7 billion, while WAM and WAL largely stayed in the mid to high 40 days.

MSLF STERLING LIQUIDITY FUND (LVNAV)

The sterling yield curve steepened in September following stronger macro data releases and a hawkish Bank of England meeting, where the Monetary Policy Committee noted that “some developments” since the August meeting had strengthened the case for tighter policy. However, movements at the front end of the curve have been dampened by high levels of excess liquidity and year-end pressures, despite markets anticipating an interest rate hike before 2022. There has been a disappointing lack of opportunities in the floating-rate note space. However, we have been active in the secondary markets and will continue to look for further opportunities here. The Fund gained assets early in the month, touching an all-time high of just under £8.0 billion on 8 September, before outflows took the Fund size back down to circa £7.7 billion to close the month relatively unchanged. Weekly liquid assets have remained fairly elevated, as we added a number of eligible assets maturing beyond the year-end crunch period.

MSLF U.S. DOLLAR LIQUIDITY FUND (LVNAV)

As anticipated, Fed officials left interest rates near zero at the September FOMC meeting, while notably increasing the reverse repurchase (RRP) counterparty limit from $80 billion to $160 billion and signaling that a moderation of their monthly asset purchase program “may soon be warranted.” Throughout the month, broader market volatility caused by concerns over the debt ceiling limit and headlines out of China did not flow through to the money market space, with 3-month LIBOR remaining range-bound near all-time lows and the Fed RRP facility continuing to take daily submissions in excess of $1 trillion, with a new high water mark at $1.605 trillion reached on quarter-end. With a flat yield curve not compensating to extend maturities and take on additional credit and interest rate risk, we remain patient in our investment approach, waiting for dislocations in pricing before putting capital to work. Portfolio WAM (weighted average maturity) and WAL (weighted average life) organically rolled down throughout the month, with weekly liquidity hovering near 60% to end the quarter.

MSLF U.S. DOLLAR TREASURY LIQUIDITY FUND (PUBLIC DEBT CNAV)

At the September FOMC meeting, interest rates remained on hold, as widely expected. The Committee’s taper plans were not yet shared with the markets, but the potential for an announcement rose and is expected at some point this year, potentially at the November meeting. Congressional gridlock on the debt ceiling continued all month. The Treasury bill market started to price in some concern as yields moved higher in the mid-October through mid-November bills versus surrounding bills. With no clear path to a debt ceiling resolution, this maturity range would be most affected if the government had a technical default on its obligations. As highlighted in our prior communications, over the summer, we had proactively sold out of all Treasury positions that matured in the months of October and November at attractive bids when the markets were not pricing in concern. Preserving capital is a primary goal in the portfolios, and the risk/ reward of owning October or November Treasuries was not compelling. At quarter-end, the volume in the RRP facility hit a new high at $1.605 trillion, underscoring supply scarcity and a continued lack of attractive investment options. With an extremely flat yield curve (excluding higher bill yields on October and November bill yields as mentioned), we continued to invest a significant amount of cash in overnight repurchase agreements and to manage the portfolios to be responsive to changes in market conditions and interest rate levels.

 
 
 
12 Month Performance Periods to Latest Month End (%)
 

Past performance is not a reliable indicator of future results. The net performance data shown is calculated net of annual fees. The sources for all performance and Index data is Morgan Stanley Investment Management. Please visit our website www.morganstanley.com/im to see the latest performance returns for the fund’s other share classes.

 
 

1 Source: Bloomberg.

 
 
 
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.
 
 
 
 
 

IMPORTANT INFORMATION

EU Cross Border Distribution of Funds Important Disclosure

This is a marketing communication. Applications for shares in the Fund should not be made without first consulting the current Prospectus and the Key Investor Information Document (“KIID”), which are available in English and in the official language of your local jurisdiction at https:// www.morganstanley.com/pub/content/imweb/im/en-gb/liquidity-investor/ or free of charge from the Registered Office of Morgan Stanley Liquidity Funds, European Bank and Business Centre, 6B route de Trèves, L-2633 Senningerberg, R.C.S. Luxemburg B 29 192. A summary of investor rights is available in English at the same website.

If the management company of the relevant Fund decides to terminate its arrangement for marketing that Fund in any EEA country where it is registered for sale, it will do so in accordance with the relevant UCITS rules.

The risk and reward category shown is based on historic data.

  • Historic figures are only a guide and may not be a reliable indicator of what may happen in the future.
  • As such this category may change in the future.
  • The higher the category, the greater the potential reward, but also the greater the risk of losing the investment. Category 1 does not indicate a risk free investment.
  • The fund is in this category because it invests in money market securities and the fund’s simulated and/or realised return has experienced low rises and falls historically.

This rating does not take into account other risk factors which should be considered before investing, these include:

  • The value of bonds are likely to decrease if interest rates rise and vice versa.
  • Issuers may not be able to repay their debts, if this happens the value of your investment will decrease. This risk is higher where the fund invests in a bond with a lower credit rating.
  • The fund relies on other parties to fulfill certain services, investments or transactions. If these parties become insolvent, it may expose the fund to financial loss.
  • While it is intended that the distributing share classes will maintain a share price of €1/$1/£1 this may not be achieved due to the creditworthiness of the issuers of investments held or changes in interest rates.

Past performance is no guarantee of future results.

Please refer to the Prospectus for full risk disclosures. All data as of 30 September 2021 and subject to change daily.

INDEX INFORMATION

One week Euro LIBID Index – One week London Interbank Bid Rate - The average interest rate which major London banks borrow Eurocurrency deposits from other banks. One Month Euro LIBID Index – One month London Interbank Bid Rate - The average interest rate which major London banks borrow Eurocurrency deposits from other banks. Euro Overnight Index Average (EONIA) – the standard interest rate at which banks provide loans to each other with a duration of 1 day within the Eurozone. FTSE 1 Month Treasury Bill Index – index calculated by FTSE that is an average of the last one month Treasury bill month-end rates. One Week USD LIBID Index – 1 week London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. One Month USD LIBID – 1 month London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. FED Funds – excess cash reserves that commercial banks and other financial institutions deposit at regional Federal Reserve banks; these funds can be onward lent to other market participants with insufficient cash on hand to meet their lending and reserve needs. One Week GBP LIBID Index – 1 week London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. One Month GBP LIBID – 1 month London Interbank Bid Rate - The average interest rate which major London banks borrow deposits from other banks. SONIA – the standard interest rate at which banks provide loans to each other with a duration of 1 day within the Sterling market.

DEFINITIONS

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. Weighted average life (WAL) – measures the weighted average of the maturities of the portfolio’s individual holdings. Public Debt Constant Net Asset Value (CNAV) MMF – a MMF qualifying and authorised as a Public Debt CNAV MMF in accordance with MMF Regulation which seeks to maintain a stable NAV and invests 99.5% of its assets in money market instruments issued or guaranteed by sovereign entities, reverse repurchase agreements secured with government debt and cash. Low Volatility Net Asset Value (LVNAV) MMF – a MMF qualifying and authorised as a LVNAV MMF in accordance with MMF Regulation which seeks to maintain a stable NAV under the condition that the stable NAV does not deviate from the NAV per Share by more than 20 basis points. In case of a deviation of more than 20 basis points between the stable NAV and the NAV per Share, the following redemption or issue of Shares shall be undertaken at a price that is equal to the NAV per Share.

DISTRIBUTION

This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations. In particular, the Shares are not for distribution to US persons.

Ireland: MSIM Fund Management (Ireland) Limited. Registered Office: The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. Registered in Ireland as a private company limited by shares under company number 616661. MSIM Fund Management (Ireland) Limited is regulated by the Central Bank of Ireland. United Kingdom: Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA, authorised and regulated by the Financial Conduct Authority. Dubai: Morgan Stanley Investment Management Limited (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai  International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158). Germany: MSIM Fund Management (Ireland) Limited Niederlassung Deutschland, Grosse Gallusstrasse 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Italy: MSIM Fund Management (Ireland)Limited, Milan Branch (Sede Secondaria di Milano) is a branch of MSIM Fund Management (Ireland) Limited, a company registered in Ireland, regulated by the Central Bank of Ireland and whose registered office is at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. MSIM Fund Management (Ireland) Limited Milan Branch (Sede Secondaria di Milano) with seat in Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy, is registered in Italy with company number and VAT number 11488280964. The Netherlands: MSIM Fund Management (Ireland) Limited, Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. Telephone: 31 2-0462-1300. Morgan Stanley Investment Management is a branch office of MSIM Fund Management (Ireland) Limited. MSIM Fund Management (Ireland) Limited is regulated by the Central Bank of Ireland. France: MSIM Fund Management (Ireland) Limited, Paris Branch is a branch of MSIM Fund Management (Ireland) Limited, a company registered in Ireland, regulated by the Central Bank of Ireland and whose registered office is at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. MSIM Fund Management (Ireland) Limited Paris Branch with seat at 61 rue de Monceau 75008 Paris, France, is registered in France with company number 890 071 863 RCS. Spain: MSIM Fund Management (Ireland) Limited, Sucursal en España is a branch of MSIM Fund Management (Ireland) Limited, a company registered in Ireland, regulated by the Central Bank of Ireland and whose registered office is at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland. MSIM Fund Management (Ireland) Limited, Sucursal en España with seat in Calle Serrano 55, 28006, Madrid, Spain, is registered in Spain with tax identification number W0058820B.  Switzerland: Morgan Stanley & Co. International plc, London, Zurich Branch Authorised and regulated by the Eidgenössische  Finanzmarktaufsicht (“FINMA”). Registered with the Register of Commerce Zurich CHE-115.415.770. Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland, Telephone +41 (0) 44 588 1000. Facsimile Fax: +41(0) 44 588 1074.

EMEA: This marketing communication has been issued by MSIM Fund Management (Ireland) Limited. MSIM Fund Management (Ireland) Limited is regulated by the Central Bank of Ireland. MSIM Fund Management (Ireland) Limited is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson’s Quay, Dublin 2, D02 VC42, Ireland.

This document contains information relating to the sub-fund (“Fund”) of Morgan Stanley Liquidity Funds, a Luxembourg domiciled Société d’Investissement à Capital Variable. Morgan Stanley Liquidity Funds (the “Company”) is registered in the Grand Duchy of Luxembourg as an undertaking for collective investment pursuant to Part 1 of the Law of 17th December 2010, as amended. The Company is an Undertaking for Collective Investment in Transferable Securities (“UCITS”).

The Funds are not a guaranteed investment and are different from an investment in deposits. The Funds do not rely on external support for guaranteeing the liquidity of the Funds or stabilising the NAV per share. The value of investments and the income from them may go down as well as up and you may not get back the amount you originally invested.

The Funds are authorised to invest up to 100% of their assets in Money Market Instruments issued or guaranteed separately or jointly by a Sovereign Entity and by any other member states of the OECD and their central authorities or central banks subject to certain conditions. Please see Prospectus for further details.

Applications for shares in the Funds should not be made without first consulting the current Prospectus, Key Investor Information Document (“KIID”), Annual Report and Semi-Annual Report (“Offering Documents”), or other documents available in your local jurisdiction which is available free of charge from the Registered Office: European Bank and Business Centre, 6B route de Trèves, L-2633 Senningerberg, R.C.S. Luxemburg B 29 192.

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.

The views and opinions expressed are those of the portfolio management team at the time of writing/of this presentation and are subject to change at any time due to market, economic, or other conditions, and may not necessarily come to pass. These comments are not representative of the opinions and views of the firm as a whole. Holdings, countries and sectors/region weightings are subject to change daily. All information provided is for informational purposes only and should not be deemed as a recommendation to buy or sell securities in the sectors and regions referenced. Information regarding expected market returns and market outlook is based on the research, analysis, and opinions of the team. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific Morgan Stanley Investment Management investment. Past performance is no guarantee of future results.

The material contained herein has not been based on a consideration of any individual client 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.

The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the applicable European or Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.

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This is a Marketing Communication.

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 a rising interest-rate environment, bond prices may fall. In a declining interest-rate environment, the portfolio may generate less income.

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