The latest figures show that inflation in the UK has reached a 40-year high of 10.1%, during a chaotic week that also saw the resignation of Prime Minister Liz Truss after only six weeks in office. In recent weeks, the turbulence of the controversial mini-budget proposed by Truss and former Chancellor Kwasi Kwarteng has also triggered a liability-driven investment (LDI) crisis, with the Bank of England stepping in to buy government debt and protect pension funds. So what does this turbulence mean for short-term investments and money market funds (MMFs)?
Tackling inflation
“Market uncertainty over the last few months has stemmed predominantly from how far and how fast the Bank of England will need to move rates to bring inflation back to target,” comments Paul Mueller, Senior Portfolio Manager at Invesco. “This has been complicated by the fact that it has been a long time since we saw inflation pressures of this magnitude, and the higher inflation prints are coming at a time when consumer and business confidence has fallen sharply.”
Mueller notes that this has led to the use of terms such as ‘stagflation’, alongside references back to the 1970s – “further complemented by increasing action by unions striking for more pay and better conditions for their members.”
At the same time, says Mueller, the Bank of England has undertaken large amounts of quantitative easing since the global financial crisis – predominantly with the purchase of UK government bonds, but also including corporate bonds – resulting in bloated balance sheets that the BofE wishes to shrink. “The combination of raising interest rates and removing liquidity from the financial system is a toxic mix when growth rates have been lower for many years and the global economy is slowing,” he adds.
Impact on WAM and liquidity
The recent market turbulence has been particularly impactful on the repricing of longer-dated sterling securities, “given the expectation that the Bank of England will need to increase interest rates even more than the market was already pricing in,” notes Hugo Parry-Wingfield, EMEA Head of Liquidity Investment Specialists, HSBC Asset Management.
As Parry-Wingfield explains, MMFs tend to hold more short-dated securities – EU regulations for Short-Term MMFs, for example, set a maximum of 60 days Weighted Average Maturity (WAM) across the whole fund. As a result, he says, HSBC AM has recently been managing its Sterling MMFs with high levels of liquidity, “which means not only has there been limited impact of this market repricing, but also on a forward-looking basis the fund is extremely well positioned to benefit from the expected interest rate hikes from the Bank of England.”
Mueller, likewise, notes that with volatility in interest rate expectations, Invesco’s MMFs have been reducing their WAM to levels much lower than they have been for many years, “and holding even more liquidity.”
Impact of the LDI crisis
Turning to the LDI crisis, Parry-Wingfield says some MMFs have seen large outflows and inflows during this period, much of which has been driven by LDI pension programmes, rather than by heightened general investor activity – “although it is also worth noting that this period of market turbulence coincided with a financial quarter end for many corporations, which can also drive flow activity every year.”
Parry-Wingfield points out that MMFs are designed to manage large flows, and have proved to be resilient to turbulent markets, “with treasurers continuing to value the core features of security, diversification and liquidity, whilst receiving commensurate levels of returns which of course have recently improved after years close to zero.”
He adds, “This has been a sterling-specific episode, and markets have settled to a degree following Bank of England bond buying, as well as changes to the UK Government’s policy.”
