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.
n 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 non-deal Brexit or new developments in the COVID crisis.