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 for reducing its balance sheet. The target range was held steady at 2.25%-2.50%. This was a pivotal change from the December meeting, which signaled a trend toward higher borrowing costs. Citing global economic and financial developments plus muted inflation pressures, the statement marked a broader shift toward risk management. The FOMC’s next meeting is scheduled for March 20, 2019.
Assets increased in January due to the imbalance of newly issued securities and the reinvestment of coupon payments and security maturities. Cash flooded the market looking for a parking place, which pushed floating security rates lower, as anticipated. The funds added fixed-rate securities as rates backed up in December to smooth out this period of lower variable rates.
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 Federal Reserve policy 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 high-tax states, has seen an increase in assets. We expect this trend to persist 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 Cut and Jobs Act of 2017, and the extreme volatility of the equity markets, impacting capital gains. We will carefully monitor income tax receipts during this current tax season, as states make adjustments to the difficult process of tax revenue projections.