At its first meeting of the new year (held on January 30), the Federal Open Market Committee (FOMC) said it will be patient on any future interest-rate moves and signaled flexibility on the path to reducing its balance sheet. The target range was held steady at 2.25%-2.50%. Federal Reserve (“Fed”) officials say the economy is in a good place and suggest further interest-rate increases will depend on incoming data easing concerns about risks to their outlook. The FOMC’s next meeting is scheduled for March 20, 2019.
Strong inflows into tax-exempt funds continued through February, keeping a lid on rates of variable-rate securities. The imbalance of newly issued securities and the reinvestment of coupon payments and security maturities continued through the month. Yields on fixed-rate securities declined as the market digested the change on future interest-rate increase expectations. The yield curve on short-duration municipal securities continues to flatten as investors increase their holdings in municipal securities.
The year 2018 was transformative for municipals as the market faced significant upheaval due to tax reform and general market volatility. The first half of the year saw a drought of new issuance, but the market finally took a turn during the last several months of the year as several large issuers entered the market for their annual cash flow borrowing. This increase in issuance, in the one-year maturity range, pushed the one-year note index to the 2% level. Strong demand plus limited supply, combined with the change in Fed policy, has pushed that level down to 1.75% as we began the new year. Demand continues to remain strong for shorter maturities due to the continued flattening of the yield curve.
Tax-exempt money market funds have seen an increase in assets, particularly in the retail sector, as after-tax yields are attractive. Assets were up approximately 10% in 2018. Interest in single-state funds, specifically those from high-tax states, has sparked an increase in assets. We expect this trend to continue as rates continue to post attractive after-tax returns.
Supply and demand continue to drive the Securities Industry and Financial Markets Association (SIFMA) Index: the average for December was 1.67%, with the index stabilizing as asset flows and supply normalized. The index averaged 1.42% for 2018. Demand will be strong for the first couple of months of the new year as new issues tend to be minimal during this time period and reinvestment demand increases. The SIFMA Index is a weekly high grade market index comprised of seven-day, tax-exempt, variable-rate demand notes produced by Bloomberg LP.
The beginning of 2019 finds the states in generally sound credit positions following a period of robust economic and revenue growth in 2018. In particular, we note that states have used higher tax receipts to bolster and fully restore reserve or “rainy day” funds to shield against the inevitable future economic slowdown. As the majority of states prepares and develops fiscal 2020 budgets, there is some emerging concern over trends in personal income tax revenue.
A number of high-tax states, such as California, New Jersey and New York, have noted declines in and lower-than-projected personal income tax collections. This may be due to a number of factors, including out-migration of very high income tax payers, the timing of estimated tax payments due to the implementation of the Tax Cuts and Jobs Act of 2017 and the extreme volatility of the equity markets, which has impacted capital gains. We will carefully monitor income tax receipts during the current tax season, as states make adjustments to the difficult process of tax-revenue projections.