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The Pandemic’s Slippery Slope for T-F Funds

The 2020 pandemic, and the policy response it generated from the U.S. Federal Reserve, greased an already slippery slope for U.S. tax-free (T-F) and municipal money-market funds. Over the following 16 months, such funds saw both their number and the assets they hold drop to historic lows.

From January 2020 – just prior to the global COVID outbreak – to May of this year, the number of tax-free funds tracked by iMoneyNet declined 14%, from 187 to 162. During the same period the assets they manage declined from $141 billion to $92.4 billion, a 35% slump.

In the case of these funds, the pool of debt with the right duration profile dried up as municipal issuers took advantage of inexpensive longer-term financing, moving away from the short-term floating-rate notes they’ve historically relied on.

Furthermore, yield declines and the Fed’s pledge to keep rates low for the foreseeable future have made it difficult for T-F funds to generate profits. With no real relief insight, some major fund providers have closed their muni funds.

The dearth of yield added more pressure to a T-F sector still trying to recover from even more consequential blows: the financial crisis of 2008 and the money-market fund reforms announced in 2014. Those reforms surprised the money-fund world by including T-F funds in the prime-fund floating-NAV requirement.

The T-F sector reached its apex in August 2008, just prior to the crisis. At that point there were 554 funds managing combined assets of $528.4 billion. That number fell below $400 billion in January 2009, below $300 billion in August 2011, below $200 billion in June 2016 (just prior to the deadline for money funds to comply fully with the 2014 reforms), and below $100 billion – for the first time since iMN began tracking T-F funds in 1981 – in the week ending March 31, 2021.

Where from here? Up, some observers say. The surprisingly rapid financial and economic recovery from the global pandemic may be launching a recovery for the tax-free sector.

Although an abundance of cash in the financial system continues to depress rates, rising inflation, a stabilizing economy, recovering municipal tax revenues, and the sheer backlog of badly needed infrastructure investments may lead to increased municipal bond issuance.

Furthermore, the prospect of Federal infrastructure largesse being evenly distributed across the country suggests new issuance will expand beyond a handful of large coastal states and Texas to cities and towns in middle America as well.

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