With a focus on liquidity, US dollar, sterling money markets have potential yet

Central
banks provided economies with ample cash as the economic effects of the
COVID-19 health crisis bit, driving down interest rates – and absolute returns
– in the process, but as Philippe Renaudin, head of global money markets, tells
senior investment strategist Daniel Morris in this interview, careful selection
and diversification mean potential for competitive returns remains in money
markets.

Daniel: Let’s first look at the money
market in the US where the Federal Reserve (Fed) recently set out an updated
monetary policy framework, adjusting to the new economic reality. How can
we now expect the Fed to react to developments? Well, the new setup means low
unemployment is no longer a reason to raise interest rates nor is fiscal
stimulus.

On inflation, the Fed will allow an
overshoot of its 2% target so that on average and over time, inflation is at
2%. For rates, this can be seen as implying that they will stay low for a very
long time. In addition, quantitative easing (QE; buying assets to inject cash
into the economy) is here to stay. In terms of asset classes, this setup is
supportive of risk assets such as equities and gold; for the US dollar, the
combination of higher inflation and low policy rates is not supportive.

What
is the condition of US dollar money markets after March’s turmoil?

Philippe: In general, major central banks including the Fed have done a good job calming the markets and providing liquidity after markets reeled this spring. The Fed actively entered the market and injected liquidity, resulting in low US yields and spreads. CDs (certificates of deposits), for example, now trade at 15bp – that is a fraction of the 80-100bp at the height at the crisis in March. So for three-month paper issued by US banks and corporates, the cost is only 0.15%, down from 1% half a year ago.

How
are you positioning your USD money market strategy?

Philippe: The key for us is to buy paper
that is liquid. This accounts for 30-40% of our portfolios. This portion is
invested in bank deposits with yields close to the fed funds fixing. The
remainder is invested in paper with different maturities, particularly from
banks, which are very active, especially in three to six-month maturities. We
actually favour these securities. With this allocation, we have been able to
provide a positive daily yield and we are confident that we can maintain this
positive level for a couple of months.

What’s
your outlook for rates in Europe?

Daniel: In the eurozone, we do not expect
much change, especially after the recent
ECB decisionto keep its monetary policy stance unchanged. In the UK,
however, we believe that the monetary stance will need to remain loose for the
foreseeable future, not least because the fiscal pendulum will soon swing back
in the direction of budget consolidation, and given the backdrop of rising
unemployment and greater uncertainty over the future relationship between the
UK and the EU. We expect the Bank of England (BoE) to do more QE rather than
cut interest rates significantly to below zero. Depending on economic developments
in the interim, there is scope for a small cut to 0%, but no earlier than
November and more likely in 2021.

What
about the sterling money market? How do you avoid negative yield?

Philippe: Similar to the Fed, the BoE provided liquidity on a large scale in the crisis, leaving market rates at close to zero and pushing spreads to very low levels. In terms of volatility, the UK market is quieter now than the US market, with rates at zero to 20bp on all types of instruments. Rates have remained under pressure: recently, we saw the UK three-month T-bill rate at -1bp. In these circumstances, it is hard to have positive yields for money market flows. The UK is a small market in terms of outstanding amounts and the numbers of issuers, so constructing a well-diversified portfolio is a challenge. Nevertheless, in the market, we are seeing rates of close to 5bp on deposits. Again, we focus on liquid instruments, particularly fixed-rate ones. We believe that further BoE measures will increase the market liquidity. We will remain cautious as we may face a no-deal Brexit or new developments in the COVID crisis.

Any
views expressed here are those of the author as of the date of publication, are
based on available information, and are subject to change without notice.
Individual portfolio management teams may hold different views and may take
different investment decisions for different clients. This document does not
constitute investment advice.

The
value of investments and the income they generate may go down as well as up and
it is possible that investors will not recover their initial outlay. Past
performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Investors’ Corner Team. The post With a focus on liquidity, US dollar, sterling money markets have potential yet appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management.