Sponsored article: Robert Evans looks at Bank of England policy and renewed confidence in the markets
Back in early April, as the financial consequences of the Covid-19 pandemic became increasingly stark, I wrote about the extraordinary movements triggered in sterling money markets. I wanted to give readers an insight into market developments since then and how we have managed the Public Sector Deposit Fund (PSDF) through this uncertainty.
First and foremost, the “liquidity crunch” seems to be behind us. We had seen corporate institutions drawing down from their bank credit facilities to replace income streams which had all but dried up. In addition, these corporate clients were redeeming significant amounts from large institutional money market funds to meet this cash shortfall.
Furthermore, this was happening at the end of financial year which can often be a busier time for redemptions. From 12 to 20 March, sterling money market funds had outflows of around £25bn or 10% of their total assets, according to Andrew Hauser, executive director of markets at the Bank of England (BoE).
In this period of turbulence money market funds have a heightened duty to be fully transparent with shareholders. Local authorities can see a complete list of holdings on the PSDF’s website as well as the liquidity position of the fund and these are updated daily.
Since that nadir, we have seen client investments return to sterling low volatility net asset value (LVNAV) money market funds in greater volumes than before the crisis. Additionally, liquidity in these funds rose as fund managers recognised further uncertainties, particularly regarding the risk of a second spike in Covid-19 cases.
Nevertheless, after the various actions of the BoE and other central bank measures, sentiment within money markets has improved substantially. As well as a 65 basis point reduction in its official bank rate, the BoE has boosted its quantitative easing (QE) programme, committing £200bn in March and a further £100bn in June. This has underpinned prices and steadied the gilt market and, after similar measures from global central banks, money markets have stabilised.
Renewed confidence is evident in the spread between the three-month sterling LIBOR rate and the sterling overnight indexed swap rate. This is the indicator we use to assess the perceived economic risk, monetary liquidity, and credit risk of the global financial banking system; stress in March and April widened the spread to 62 basis points. At the time of writing it has now fallen back to just 11 basis points, very close to the five-year average.
The removal of the liquidity premium, combined with huge central bank stimulus, has resulted in sharply lower yields over the last six weeks. Data releases indicating that the desired ‘V’ shaped recovery may not happen, and the pandemic could have structural after-effects, have compounded this movement.
With a watchful eye on potential fallout from ongoing Brexit negotiations, the BoE has subsequently opened the door to negative interest rates, something it has previously rejected. It did this by saying it was not ruling them in, or out, but was looking into their impact on the UK financial system.
This intervention spurred the forward market to price a negative Bank Rate within the next 12 months, and we saw the UK gilt curve turn negative for issues of up to seven years. The Treasury also issued a gilt on a negative yield, a first for the UK.
In the last few days, BoE governor Andrew Bailey announced that he wanted to scale back the gilts purchased under the QE programme before starting to increase the Bank Rate from its record low. This is a further indication that the Bank Rate looks very unlikely to increase for some time to come.
Managing the PSDF in a low yield environment
As we expect rates to stay lower for a prolonged period, we have looked to extend the weighted average maturity of the fund to lock in enhanced yields at the longer end of the curve, but only where we have confidence in credit quality.
Security and liquidity are of paramount importance to our clients as they deal with the developing impact of Covid-19, the uncertainties of further government funding, and the ongoing reductions in local revenues. Since the start of the quarter, the PSDF’s one-week liquidity position has averaged 52.5% of total assets and has not dropped under 48% at any point. This compares with a fund average of under 40%. We are continuously looking to expand our list of counterparties to improve diversification and enhance credit quality.
CCLA has been managing cash funds for over 60 years and our experience of previous crises and our close client relationships have held us in good stead. While many economists do not expect the BoE to take rates negative, it is certainly a live risk which councils should try to prepare for as possible. Regardless of events, CCLA will monitor the position closely and our PSDF will continue to provide a sector specific, trusted and competitive haven for our clients’ cash.
Robert Evans is a cash fund manager at CCLA.
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