Insights
Market Insights
Cruise Control
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Market Insights
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February 15, 2024
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Cruise Control
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February 15, 2024
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Cruise Control
Cruise Control |
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Federal Reserve Board1
The Federal Open Market Committee (FOMC) held the federal funds target rate at its current range of 5.25% to 5.50% in January. The press release included several adjustments—most notably removing any reference to “policy firming.” The statement updated the forward guidance to indicate policy rates would be held at current levels. FOMC members see the risks around employment and inflation moving into “better balance.” Federal Reserve (Fed) Chair Powell pushed back on market forecasts for a more aggressive rate-cutting cycle in 2024 than what the Fed had illustrated in its most recent economic projections.
European Central Bank1
The European Central Bank’s (ECB) Governing Council left the deposit rate unchanged at 4.00% at the conclusion of its policy meeting on January 25. The Governing Council noted that inflation has broadly declined as expected. Higher rates have also reduced demand in the economy, which has contributed to lower inflation. The ECB reiterated its prior meeting messaging that policy rates need to remain “sufficiently restrictive” and the policy committee will remain “data-dependent” going forward.
Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 6-3 to hold the Bank Rate steady at 5.25% at the conclusion of its meeting on February 1. Two dissenting members preferred to increase the rate 0.25% to 5.50% while one dissenting member preferred to decrease rate 0.25% to 5.00%. The BoE noted that inflationary pressures are “abating across the euro area.” At 4.0%, December headline 12-month inflation data came in below November’s reading and committee members are projecting inflation to fall to the 2% target in the second quarter, albeit temporarily. While striking a balanced tone around risks, the MPC reiterated that rates will need to remain “restrictive for sufficiently long” for inflation to sustainably return to its target.
PORTFOLIO STRATEGY
Government/Treasury Strategy
In January, weighted average maturity (WAM) climbed to above 50 days across our portfolios, as the FOMC has clearly signaled the next policy move will likely be a cut. Weighted average life (WAL) has decreased somewhat across our funds accordingly as we rotated out of Treasury floating-rate notes and selectively into SOFR-based (secured overnight financing rate) floating-rate notes.
The Fed has a very difficult job to do—with inflation improving but data slowing, the committee needs to be extra vigilant in their communication and implementation. We believe it makes sense to prepare for a potential rate cut as early as March, but with May or June the likely base case. Additional tailwinds for bond markets may appear with the implementation of buyback programs in 2024 and with a reduction in the speed of quantitative tightening.
Treasury and Agency auctions have remained orderly, as supply has been well absorbed. We have no concerns with respect to T-bill liquidity in the current environment.
2024 will increasingly follow the election, given the crosscurrents of the political sphere with the economic sphere. The FOMC is highly data dependent, and the next two months of payrolls and inflation data will be crucial.
Prime Strategy3
January was defined by Fed officials pushing back on market pricing of a rate cut at the upcoming March FOMC meeting and concluded with a dovish tone, where the previous tightening bias was removed from the statement and Chair Powell explicitly indicated that a March rate cut was unlikely based on the totality of data so far. While we continue to prefer adding fixed-rate securities to the portfolio, locking in yields and avoiding coupon reset risk associated with floating-rate notes, we remain cautious extending the maturity profile of the Funds as spreads have continued to grind tighter throughout the month, approaching lows last seen at the end of 2021. Over the month, the WAM and WAL of the Funds declined by approximately 10 days compared to year-end 2023, as a result of our cautious approach to the current spread environment.
With a number of issuers out of the market following their extension in December, there is excess cash waiting to be put to work and dealer balances sheets remain unconstrained to provide liquidity.
Tax-Exempt Strategy
With the FOMC holding the benchmark rate unchanged in the target range of 5.25%-5.5% for the fourth straight meeting, signaling no interest rate cut in March and similarly indicating that “any adjustments” to the benchmark rate likely won’t be suitable until “inflation is moving sustainably toward 2%,” we continued to extend WAM and WAL, buying tax-exempt commercial paper (TECP) in March-May tenors, where seasonally weaker technicals provide additional spread.
Constrained by tax-exempt money market outflows, the SIFMA Municipal Swap Index,4 which measures yields for weekly variable rate demand obligations (VRDOs), remained volatile in the first month of 2024, trading within a 265 basis point range, from a low of 1.90% on January 10 to a high of 4.55% on January 24, while resetting on January 31 at 3.74%, or 148% of the 30-year BVAL Municipal AAA Yield.
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.
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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.
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