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The Federal Reserve delivered an emergency 50 basis point rate cut as additional insurance against downside economic risk due to the coronavirus on March 3rd. The committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy. The next meeting is scheduled for March 18th and the market is anticipating additional support from the Federal Reserve.
Assets in Tax-Exempt Money Market funds continue to be range bound during the first few months of the year. The yield curve is inverted and keeping the rate on Variable Rate Demand Notes attractive compared to fixed rate notes and we see continued strong demand for these securities. The securities are highly liquid and are used to meet redemptions and adjust quickly to market changes. They are priced off from the weekly SIFMA index. (SIFMA Index is a weekly high-grade market index comprised of seven-day tax-exempt variable rate demand notes produced by Bloomberg LP).
The tax-exempt market continues to see steady inflows keeping demand strong. Retail demand has remained strong particularly for debt issued in high tax states, New York, California, New Jersey, etc. Limited new issue supply, combined with the change in Fed policy, resulted in a downward trend in fixed income tax-exempt yields moving the one-year index to below 1.00%. There is zero yield differential between one-year notes and six-year bonds at this point. Demand continues to remain strong for shorter maturities due to the continued flattening of the yield curve and strong inflows into taxexempt funds particularly longer dated portfolios.
January and February are historically very low new issuance months and a dearth of new issue supply combined with cash entering the market from reinvestment proceeds, maturities and coupon payments have kept a lid on yields. The funds purchased securities with longer maturities, during the final weeks of December as we saw a back-up in rates in an effort to buffer the lower yields.
Most states enter the second half of fiscal 2020 in sound financial shape as the fiscal 2021 budget process is underway. In our view, a variety of favorable economic conditions generating revenue growth should result in overall credit stability for the sector. Long term budgetary challenges persist in the area of rising fixed costs encompassing pension obligations, retiree health benefits and Medicaid.
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