2019 Global Cash Outlook Innovations in Cash Global Rates Forecast We review our expectations for euro, sterling and dollar performance in 2019. We expect the European Central Bank to wind down its asset purchase program, the outcome of Brexit and the supply and demand imbalance in short-term Treasury debt will affect the current market cycle. Todd N. Bean, CFA Vice President and Head of US Traditional Cash Strategies 1 Money-Fund Forecast
In 2019, euro money market funds (MMFs) are expected to continue posting negative yields, after the European Central Bank (ECB) completes the wind down of its asset purchase program in December 2018. Sterling MMF performance will depend on the outcome of Brexit negotiations. We believe that the most likely scenario is a soft Brexit, followed by mediocre economic data and two 25 basis points (bps) rate hikes in 2019. Dollar-based prime and government fund yields are likely to rise by at least 100 bps in 2019, driven by Federal Reserve (Fed) rate hikes. A supply and demand imbalance in short-term Treasury debt could push prime yields higher, and could prompt the Fed to stop rolling Treasury debt off its balance sheet. 2019 Global Cash Outlook 2
The Bank of England s MPC Rate for 2019 Had it not been for the Brexit vote in 2016, sterling rates today might look more like US dollar rates. Both core and headline consumer inflation has been tracking above 2% year-over-year since early 2017. The labor market is robust, with the unemployment rate trending to drop below 4%. Brexit seems to be the only slippery part of the road. Some experts look at it like this: there is a 25% chance of a hard Brexit, with no deal reached. We believe that this is the worst case scenario for markets. At the other extreme, there s a 15% probability that an election will be called, followed by a new referendum. Polls have found that a majority of British people now support continued European Union membership 1, but a referendum would prolong the uncertainty. The most likely scenario, at 60%, is a soft Brexit, with withdrawal terms agreed upon between London and Brussels. In our view, this is also the best outcome for markets. It would produce positive sentiment and could lead the U.K. s Monetary Policy Committee (MPC) to implement more than the one hike currently priced for 2019. Markets continue to reflect this uncertainty with the probability of a next hike from the MPC constantly changing. As at 1 November the markets priced near or on a 100% probability for an August 2019 hike of 25 bps. In early fourth quarter of 2018, the markets signaled only about a 75% probability of a 25 bps rate hike before August, but as we have seen in 2018, sentiment can shift quickly. 1 https://www.businessinsider.com/brexit-polls-show-britain-wants-to-remain-in-eu-2018-9 The European Central Bank Policy Rate for 2019 The ECB s asset purchase program will wind down at the end of December. The ECB is likely to maintain the size of its balance sheet (over 4.6 trillion) through 2019, although we think it could start to consider rolling off some corporate bonds and/or asset-backed securities in 2020. Going forward, the ECB s messaging will be critical. So far, the bank has been successful in avoiding a taper tantrum interest rate spike when communicating and implementing the end of its asset purchase program. As for ECB rate hikes, the market is signaling a 42% probability of a 10 bps hike in fall of 2019 and a 19% probability of a 20 bps hike at that time. Yet there is significant time between now and then with multiple events that could disrupt those probabilities. The Federal Reserve s FOMC Policy Rate for 2019 We expect the Fed to raise rates by 25 bps three times in 2019. This is in line with the Fed s dot plot and in sync with its projection of economic growth, employment strength and moderate inflation. Additionally, we believe technical factors could put upward pressure on money market yields. This may upset the Federal funds rates channel and may cause a credibility event for the Fed if the Federal funds effective rate trades outside of their target rate channel. Two major technical factors Fed s balance sheet normalization and repatriation of corporate cash held overseas have decreased demand for short-term assets. Meanwhile the tax cut has increased the Treasury s borrowing needs 2, expanding asset supply. This 2019 Global Cash Outlook 3
increase in supply and decrease in demand is pushing money market interest rates higher. It is also increasing repurchase agreement rates, effectively reducing the overall supply of cash available for short term funding. When the Fed hiked interest rates in June, it altered the way it moved a key rate: interest on excess reserves (IOER) or the interest rate that the Fed pays on reserves that banks deposit at the Fed. Previously, the Fed set IOER as the upper bound of its target rate range; when the target was 1.50% to 1.75%, the Fed set IOER at 1.75%. But because of the upward pressure on the Federal funds rate, when it raised its target range to 1.75% to 2.00%, it set IOER at 1.95%, 5 bps lower. We think that this upward pressure on the Federal funds rate will continue in 2019. If so, the Fed may continue to increase IOER at a slower rate than their target rate range. The Fed may also address the excess supply of short-term funding needs by halting the roll-off of treasury securities from its balance sheet; it currently can shed up to $30 billion Treasuries per month under its balance sheet normalization program. It is possible that if upward pressure on rates persists the Fed may resume its purchase of US Treasury debt, most likely purchasing short-term Treasury bills to drain liquidity out of the market. 2 https://www.bloomberg.com/news/articles/2018-07-30/treasury-raises-borrowing-outlook-with-2h-hitting-769-billion 2019 Global Cash Outlook 4
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