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The fourth quarter of 2017 had several significant events culminate that shifted market dynamics and provided opportunities for municipal investors. An increase by the Federal Open Markets Committee (FOMC) of their policy rates, as well as tax reform legislation provided a backdrop of uncertainty that worked together to move short duration municipal yield higher. Throughout the quarter Northern Trust portfolio managers focused their efforts to position the portfolio to take advantage of higher yields while minimizing fluctuations of the Portfolio’s net asset value.
As we moved through the fourth quarter, municipal fixed income investors were surprised to see that legislators had proposed a tax reform package that would impact the municipal markets. The proposed tax reform legislation included the elimination of the practice of municipal prerefunding as well as the issuance of private activity bonds. The uncertainty surrounding this legislation ultimately created a flood of supply toward the year end as issuers rushed their deals to market before the bill could become law. Municipal issuance for the month of December hit approximately $56 billion, breaking the previous monthly record of $54.7 billion set in December of 1985. The large quantity of supply ultimately had the effect of pushing short duration tax exempt rates higher in the money market space.
In addition to technical factors in the municipal market, short term fixed income yields shifted higher as the FOMC raised their policy rates by 25 basis points (0.25%) after their December meeting. By quarter end, the Securities Industry and Financial Markets Association (SIFMA), 7-day high-grade market index comprised of tax-exempt weekly variable rate demand notes (VRDNs), reached 1.71%, the highest level in nine years. Northern portfolio managers continued to invest cash balances by primarily purchasing daily and weekly VRDNs due to the relative attractiveness and liquidity profile of the asset class. The significant quantity of VRDN holdings worked to stabilize the portfolio asset value given that municipal VRDNs can be tendered a price of par within five business days. Throughout the quarter the Municipal Portfolio’s target weight average maturity was seven days.
An investment in the Money Market Funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other governmental agency. Although the Funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Funds.
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