Ultra Short Tax-Free Income Fund Commentary
How did the municipal bond market perform?
The employment situation and consumers continue to be the strongest components of the U.S. economy. Monthly nonfarm payrolls gained an average of 157,000 for the quarter and the unemployment rate fell to 3.5% at the end of September. U.S. consumers remained resilient despite the ongoing trade war, which has not shown signs of getting resolved, as well as signs of an economic slowdown, especially from the manufacturing sector. The Institute for Supply Management Non-Manufacturing Index1 fell to 52.6 in September, which was its lowest level since August 2016. On the economic growth front, market participants are expecting third-quarter gross domestic product1 growth to fall below 2%.
The Federal Reserve Board (the Fed) lowered the overnight lending rate by a quarter point at the Federal Open Market Committee (FOMC) meetings in July and September and reiterated its stance that it will continue to monitor the trade situation and economic data in the coming months to determine whether further cuts are needed.
The short end of the municipal market presented an opportunity to buy fixed-rate paper at attractive levels at the outset of the quarter, but rates drifted steadily lower until mid-September, when they began to move higher.
Yields on variable rate demand notes (VRDNs) were fairly steady during the period, averaging 1.40% for the quarter. However, one surprise came after the Fed lowered rates at the September 18 FOMC meeting. VRDN yields typically fall after a Fed ease, but they rose about 25 basis points (0.25%) in the second half of September as quarter-end pressure led remarketing agents to keep the rates elevated in an attempt to entice crossover buyers and reduce inventory.
The low rate environment presented the biggest challenge for investors in the short end of the muni market during the quarter. Muni bond funds continued to see inflows at a record pace, which created even more pressure from a supply and demand perspective.
What were your primary investment strategies during the quarter?
The Fund maintained a mix of fixed-rate paper and VRDNs, which proved to be effective for most of the quarter, particularly in the second half of September, when VRDN yields rose despite the Fed lowering rates. The Fund also extended the duration through fixed-rate purchases in the 9- to 12-month range. This was done in anticipation of future Fed rate cuts, which should cause VRDN yields to fall.**
The Fund outperformed the benchmark in September, but slightly underperformed for the quarter.
How do you expect to position your Fund in the coming months?
The Fed has indicated that it would most likely lower the overnight lending rate at least one more time in 2019, which will most likely affect yields in the short end of the muni market.
The Fund will continue to look for opportunities to extend the duration by purchasing fixed-rate bonds in the 9- to 12-month range. We believe the fourth quarter is often an attractive time to buy due to supply and demand imbalances.**
Bloomberg Barclays 1-Year Municipal Bond Index includes bonds with a minimum credit rating of BAA3, are issued as part of a deal of at least $50 million, have an amount outstanding of at least $5 million, and have maturities of 1 to 2 years. The index is unmanaged and does not reflect the fees and expenses associated with a mutual fund. An investor cannot invest directly in an index. Gross Domestic Product (GDP) measures the market value of the goods and services produced by labor and property within the respective country/economic region. ISM Non-Manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms' purchasing and supply executives, within 60 sectors across the nation, by the Institute of Supply Management (ISM). The ISM Index tracks economic data, like the ISM Non-Manufacturing Business Activity Index. A composite diffusion index is created based on the data from these surveys that monitors economic conditions of the nation.
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