MONEY MARKET | November 2022

Tax-Exempt Money Market Commentary

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Colleen Meehan

Senior Portfolio Manager

The Federal Reserve (Fed) lifted interest rates by another 0.75% to combat inflation and signaled plans to keep raising rates, possibly in smaller increments, to higher levels than previously anticipated at its November 2 meeting. This was the fourth consecutive 0.75% rate increase and lifts the federal funds range to 3.75% to 4.00%. During his press conference, Chair Powell said, “…the question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive.” He also commented, “It’s very premature in my view to think about or be talking about pausing our rate hike. We have a ways to go…we need ongoing rate hikes to get to that level of sufficiently restrictive.1 In our view, the question is no longer how fast but how high rates will go. US businesses reported strong hiring and wage increases in October. The last Federal Open Market Committee (FOMC) meeting of 2022 will be held on December 14.

As the Fed looks to tamp down inflation, it is a good time to look at tools state and local governments utilize to plug budget deficits—raising revenues, reducing expenses or tapping rainy day reserves. Balanced budget requirements are constitutional or statutory rules that require states to balance their budgets, and the stricter requirements prohibit them from maintaining a multi-year deficit. In 2015, 46 states and the District of Columbia had balanced budget requirements. States are currently sitting on record reserves due to better-than-expected revenues and large federal aid during the pandemic. In fiscal year 2021, state reserves increased roughly 50% to a record high $114.6 billion, according to Pew Research.

We believe California is an important barometer of economic strength in the municipal bond market with a $3.4 trillion economy that represents more than 14% of the nation. The state leads the country into a recession and is amongst the first sates to recover coming out of a recession. State tax collections have fallen below expectations for four months in a row, and there is an 80% chance California will be about $8 billion short when its fiscal year ends next summer per the nonpartisan Legislative Analyst’s Office. While the state has close to $40 billion in reserves for fiscal year 2022, a deep recession could strain finances in coming years, a bellwether as we closely monitor other states. The governor recently vetoed several spending bills that were not part of the state budget, noting declining revenues.

The Securities Industry and Financial Markets Association (SIFMA) Index is a seven-day high-grade market index reported to the Municipal Securities Rulemaking Board. It averaged 2.37% for the month of October and should increase in step with taxable rates. Municipal money market funds have seen assets increase the past few months as investors seek out higher yields and the stability of the money market space. The front end of the yield curve, securities maturing within one year, has seen yields rising with the anticipated Fed increases and continued outflows from longer-term municipal bond funds. We will continue to maintain very high levels of liquidity with variable rate security indexes trending higher, and we will seek to provide shareholders with market returns.

Outflows continued from long-term municipal bond funds during October as rates continued their ascent. City and state governments are hesitating to sell debt as yields climb, and the dwindling supply of municipal bonds could stabilize market prices. Demand continues to remain strong for shorter-dated paper as investors stay in the shorter end of the market.

Our experienced credit team will continue to review our current holdings and any purchases going forward. All the securities purchased receive a minimal credit risk designation prior to purchase and are periodically reviewed for any changes to the credit outlook. We continue to maintain very high grade, liquid portfolios.

1Source: Federal Reserve, Preliminary Transcript of Chair Powell’s Press Conference, November 2, 2022.

All investments involve risk, including the possible loss of principal. Certain investments involve greater or unique risks that should be considered along with the objectives, fees, and expenses before investing.

BNY Mellon Investment Management is one of the world’s leading investment organizations encompassing BNY Mellon’s affiliated investment management firms and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the corporation as a whole or its various subsidiaries generally.

Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.

This material has been provided for informational purposes only and should not be construed as investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. This information contains projections or other forwardlooking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

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