On September 26, 2018, Federal Reserve officials increased the federal funds rate by 0.25% to 2.00%-2.25% as economic activity has been rising at a strong rate and unemployment has stayed low. The Federal Open Market Committee (FOMC) expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the committee’s 2% objective. The next FOMC meeting is scheduled for December 19 and the market is anticipating another 25-basis-point increase, which would bring the federal funds rate to a 2.25% to 2.50% target range.
The year 2018 has been transformative for municipals as the market faced significant upheaval due to tax reform and general market volatility. The new-issuance drought, brought on by these events, finally took a turn during the past few months as several large issuers entered the market for their annual cash flow borrowing. This increase in issuance, in the one-year maturity range, has pushed the one-year note index to the 2% level. Demand continues to remain strong for shorter maturities due to the continued flattening of the yield curve and increasing federal funds rate. The funds continue to maintain relatively shorter weighted average maturities (WAMs), thus enabling the funds to capture the increase in yields as the Federal Reserve continues on the current path.
Tax-exempt money market funds have seen an increase in assets, particularly in the retail sector, as after-tax yields are attractive. Interest in single-state funds, specifically those of high-tax states, has produced an increase in assets. We expect this trend to continue as rates keep posting attractive after-tax returns.
Supply and demand continue to drive the Securities Industry and Financial Markets Association (SIFMA) Index, but the month of November saw the index stabilize as asset flows and supply normalized. The index averaged 1.67% for the month of October and 1.46% since July. The SIFMA Index is a weekly high grade market index comprised of seven-day tax-exempt variable-rate demand notes produced by Bloomberg LP.
We are nearly at the midpoint of the 2019 fiscal year for most states, and credit quality remains stable. This continues to be due to the robust economy, as job growth and consumer spending contribute additional personal income tax and sales tax revenue to the states’ treasuries. Many states have recognized the importance of continuing to bolster rainy-day and budget-stabilization funds in advance of an economic slowdown, while spending generally remains constrained.
A divided Congress following the midterm election is unlikely to result in any significant legislation impacting the states, although bipartisan efforts to stimulate infrastructure spending may proceed.