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Monthly Cash Review – EUR State Street EUR Liquidity LVNAV Fund, February 2024

Policy

There was no European Central Bank (ECB) Governing Council (GC) meeting in February. The next meeting is scheduled for 7 March.

Data

  • Headline inflation for January declined to 2.8% from 2.9% in December, in line with expectations. While energy inflation increased, this was more than offset by the decline in food inflation. Core inflation remained stable at 3.3%. However, services inflation remained stable at 4.0%, unchanged since November.
  • Headline inflation for February declined in five out of six major German states. Data for France and Spain was broadly in line with expectations, with headline inflation falling due to declines in food inflation. This implies that eurozone headline inflation will have declined broadly.
  • The second estimate of GDP for Q4 2023 was unrevised from the flash estimate that showed growth of 0%.
  • The composite purchasing managers index (PMI) increased to 48.9 in February from 47.9 in January, marginally better than consensus expectations of 48.4. Readings below 50 are indicative of contracting activity. The improvement was driven by services, which improved to the 50.0 'no growth' mark.
  • The eurozone unemployment rate for January declined marginally to 6.4%.
  • The ECB published negotiated wages data for Q4 2024, which showed a slight decline in the rate of growth to 4.5% from 4.7% in Q3 2023. This is partly distorted by the data from Italy, where advance payment of wages due in 2024 was included. Wage growth in Germany and France slowed by 0.4ppts and 0.6ppts, respectively.

Outlook

Following the January ECB meeting, the bank confirmed that decisions will continue to be made on a meeting-by-meeting basis, based on economic data with the emphasis on inflation. Guidance at the time was that market expectations for a rate cut in March were premature. The ECB minutes noted that a tightening in financial conditions had been seen following the ECB communication. During an economic committee hearing at the European Parliament, ECB President Christine Lagarde reiterated the assessment that while activity was sluggish, forward-looking surveys pointed to a pickup in activity. While inflation is expected to continue slowing down, Lagarde cautioned against rushing interest rate cuts, given that services inflation remains high, labour market conditions remain tight, and wage pressures continue to be strong. Several members of the Governing Council want to see a clear slowdown in wage growth before considering cutting interest rates. ECB member Yannis Stournaras has stated that rates will not be cut in March and only in April if economic data warrants it, and that a first cut is more likely in June. ECB member Madis Muller said that the market needs to be patient with the first rate cut. Overall, the ECB stance appears to be one of caution in relation to the timing of interest rate cuts, and that the risk of cutting rates too early outweighed the risk of cutting rates too late.

The key piece of information ahead of the ECB meeting on 7 March is the eurozone inflation data. A lower-than-expected print could lead to pricing for April becoming more balanced. Furthermore, the next ECB inflation forecasts are due in March, which will likely shape the bank’s outlook and provide additional guidance to the market. The question remains around the timing of the first interest rate cut. Market implied rates for March have remained stable, ending the month at 3.89%. The market implied rate for April started the month at 3.66% and ended at 3.85%. This is similar for each of the meetings. The year-end implied rate is now 3.00% having increased during the month from a starting level of 2.43%.

Forecast are based upon estimates and reflect subjective judgments and assumptions. There can be no assurance that developments will transpire as forecasted and that the estimates are accurate.

Fund

The weighted average maturity (WAM) averaged 32 days in February and the weighted average life (WAL) averaged 55 days. Investments were made in high-quality credit issuers, out to three months, with some selective longer-dated investments. Investments in sovereign, agency and government-guaranteed holdings were maintained to provide high credit quality and maintain liquidity buffers. Investments in bank floating money market securities, linked to the €STR overnight index, were increased, offering attractive spreads and diversification. Asset-backed commercial paper continued to be in good supply, offering flexible duration and attractive returns compared to vanilla paper. Liquidity and capital preservation remained the key drivers for the portfolio.

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