Sometimes meetings of the Federal Open Market Committee bring great market changes, sometimes not. Yesterday’s meeting was a Not. Bottom line: the Fed said not much and investors, skittish over market direction, were relieved, with both equities and bonds rising in price after the meeting’s concluding announcement.

Most public funds investors limit their involvement to the short-term markets, and for them the path for the federal funds or similar overnight rate is mighty important as it marks the track for short-term yields. There was nothing in the post meeting announcement or the chair’s press conference to suggest a significant change in the outlook for money market rates. As the above chart shows, the implied overnight rates for pre-and post-meeting were close. At the market close the May 2025 rate was lower by six basis points (to 4.28%) and the rate next March was lower by 13 basis points (to 3.54%) after the meeting. (The May level implies the Fed will hold rates steady at the next FOMC meeting.) That’s hardly a move to motivate big changes in investment strategy.

Jerome Powell sought to soothe investors with repeated comments that the economy is in a pretty good place.  True, the Fed’s Summary of Economic Projections reduced the gross domestic product outlook from 2.1% to 1.7% this year and raised the outlook for inflation from 2.5% to 2.7%. These are modest changes, given the magnitude of fiscal policy and tariff moves that the Trump administration is advocating. Powell also discounted talk of a recession.

Of course, the chair must be careful about what he says.  Fed officials always seem to speak optimistically. After all, think of what investors would conclude if they did not.

 

State and Local Government Investment Balances Were Stagnant in the Last Months of 2024

State and local government investment balances declined in the fourth quarter of 2024 despite high short term investment rates that boosted earnings. The Federal Reserve’s Financial Accounts of the United States release for the fourth quarter of 2024 showed state and local government investment balances declined by nearly $14 billion to $3.993 trillion. The decline should be a signal of caution for portfolio managers as economic uncertainty rises and the possibility of massive cuts in Federal spending could upend state and local budgets and lead to significant drawdowns of reserves in coming months. This is the first decline in investment assets in at least five years.

  • The decline follows a period of strong growth in balances, with investment assets up by $975 billion since 2020.  Larger investment account balances fueled the growth of local government investment pools and demand for Treasury securities. Spend-downs may have the opposite effect.
  • States appear to have experienced the brunt of the decline. The Federal Reserve data does not distinguish between state and local government accounts, and there is no comprehensive accounting for current state investment balances but a recent post by the National Association of State Budget Officers reported that after a post-Covid build up of budget reserves, states have begun to spend down these funds as budgets tighten.
  • Local governments in a number of large states, including California, Florida, and Texas, normally experience strong revenue inflows in December. Yet overall the fourth quarter the Fed release reported that overall investment balances declined.

Drill Down.

State and local government investment assets totaled $3.993 trillion at the end of 2024. They grew strongly in the past four years, fueled by a surge in Federal grants for post-Covid recovery and strong tax receipts, particularly in states with taxes that capture gains in stock or real estate values. State budget officials reported building up rainy day funds, and many local governments appear to have followed suit. Investment portfolios grew and as short-term interest rates rose from nearly zero in 2021 to five percent plus last year, investment earnings became a significant contributor to budgets.

Most of the increase in balances was invested in Treasury securities which are risk-free and highly liquid. Treasury holdings grew by $576 billion in this four-year period. Bank deposits also increased, growing by $121 billion. What is notable about the bank deposit growth is that it was concentrated in transaction accounts which generally do not earn at money market rates.  Higher balances could be required to offset higher banking costs. They could also be a consequence of liquidity provisioning which would leave excess liquidity in these types of accounts—accounts that generally do not provide market-based investment rates.

The fourth quarter Federal Reserve report shows a continuation of a multi-year trend toward low risk and liquid investments.  More than 50% of balances were in Treasury or Federal agency securities, and another 19% were in bank deposits which generally are insured or collateralized.  A look-back over four years shows state and local governments increased commercial paper and corporate bond holdings by $260 billion. This compares with the $576 billion increase in Treasuries. At the end of 2024, credit holdings totaled $561 billion, nearly double the level of 2020, but they were only 14% of overall investment assets.

The Federal Reserve accounts for LGIP balances indirectly in the report. They are not broken down separately, which makes some of the data hard to interpret. It seems likely, however, that that most of the commercial paper is held by LGIPs, with individual accounts of states and localities holding only small relative amounts. 

The Bottom Line.

Recent anecdotal reports from public sector investment managers acknowledge a slowdown in portfolio growth and in some cases a draw down of portfolios. Meanwhile the Federal Reserve’s quarterly report confirms that the aggregate portfolio characteristics of states and localities strongly favor risk-free or low risk securities that should be highly liquid.