Northern Trust Asset Management Monthly Market Commentary for May 2021
Eurozone Market Update
The European Union’s vaccine rollout is progressing well, with around 46% of the adult population receiving at least one dose. Measures to reopen tourism are being discussed which would help an economic rebound, particularly for southern European countries that rely on it. The European Commission revised up its economic growth forecasts for the Eurozone to 4.3% for 2021 and to 4.4% in 2022 (both 3.8% previously). Contrary to the European Central Bank's forecasts, the market is pricing in the risk that inflation will continue to post higher than expectations. The five-year forward inflation expectation rate reached a peak of 1.64% mid-month, but importantly this is still below the central bank’s 2% target and comments from its members remain dovish.
UK Market Update
As expected, the Bank of England (BoE) left its policy unchanged at the May meeting. There was a technical taper to the weekly pace of purchases from £4.4 billion to £3.4 billion a week in the BoE's closed-end quantitative easing programme, but the bank’s overall commitment to asset purchases hasn’t changed. The Monetary Policy Committee voted unanimously to keep the interest rate at 0.10% and voted 8-1 to maintain the same level of asset purchases. The BoE also accelerated its economic growth forecast with the faster progress of the Covid-19 vaccine rollout. Still, the committee was more cautious around its inflation projections, which are below their 2% long-term target. It continued to stress the temporary nature of the above-target inflation levels, which are mostly attributed to energy prices.
US Market Update
Excess dollar liquidity continues to be problematic for short-term investors as yield levels continued to compress in May due to the increased demand. Yields on repurchase agreements for Treasury collateral traded at half a basis point, while agency and agency-mortgage collateral traded at 1 basis point. As T-bill paydowns and inflows into government money market funds continue, investors have been forced to use the Federal Reserve reverse repo (RRP) facility to find a home for their cash in a much greater capacity. On May 3, the facility was used by 26 counterparties for $130 billion. By May 27, the number of participants increased to 450 for $485 billion (see Chart of the Month). This puts downward pressure on all instruments, and the pressure will continue until the debt ceiling is resolved.
Global Outlook
The excess US dollar story we projected earlier in the year continues to dominate money markets in all currencies. June’s focus will be on the Fed, to see if they echo market concerns about the surge in its reverse repo facility. This is removing supply and compressing money market yields, creating a decline in liquidity conditions and increasing stress in money markets. The Fed could adjust rates, by either increasing the RRP rate and interest on excess reserves (IOER); or introducing new term RRP. Elsewhere, June's central bank meetings may provide early indications on changes to the pace of asset purchase programs.
Chart of the Month: May's Spike in Fed Reverse Repo Volume
A surge of investor cash into the Fed’s reverse repo program has hit its highest volume since December 2016 resulting in downward pressure in yields.
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