Municipal money market fund yields still sky-high but starting to drift back down to earth

The federal tax-free Fidelity Municipal Money Market fund (FTEXX) now has a 7-day yield of 5.00%, down from 5.77%, which is equivalent to 8.05% taxable in the 35% tax bracket or 7.26% for the 28% tax bracket. Progress on The Big Bailout Bill during the week probably freed up the credit markets a bit.

Why the huge spike in yield? Probably simply because of the massive redemptions from money market funds last week which resulted in a buyers market for the very short-term tax-free securities that municipal money market funds buy and a lower price means a higher yield.

Now, why these yield spikes are occurring for tax-free funds and not for most taxable funds is somewhat a mystery, but is probably simply related to differences in how the municipal market works. Or, maybe some of the old ARS securities have finally been repackaged to be acceptable for money market funds and that caused the glut.

I would note that a bunch of taxable money market funds are now showing up with much higher yields than the Fidelity Select Money Market fund (FSLXX) 7-day yield of 2.65%. According to Crane Data, there are three funds in the 3+% range and one at 4.73% that are supposedly taxable.

The $64 billion question is how long this pricing anomaly will continue or whether in fact this is part of "the new world financial order." It has been over two weeks since municipal money market funds leaped above 3%.

WARNING about shuffling cash between funds: The new Treasury Money Market Fund Guarantee Program ONLY covers balances in any particular fund as of Friday, September 19, 2008. That is really stupid, but that is the way it is. In other words, if you leave your funds where they were on 9/19, the principal is protected, but any accrued interest or new deposits are not. And if you move money from one fund to another, you LOSE the protection you had in the old fund and DO NOT get protection for that same money in the new fund. Also, this new protection is only TEMPORARY and due to expire in three months unless the Secretary decides to extend the program due to ongoing financial turmoil (which they refer to as "dislocations in credit markets.")

OTOH, I personally am not worried about the safety of Fidelity money market funds, so the stupidity of the new Treasury program is irrelevant to me.

Fidelity (and Vanguard) still have not decided whether to participate in the Treatury guarantee program, but given their credibility it is not as important for them. For anybody other than Fidelity and Vanguard I would insist on the guarantee program.

See: Treasury's Temporary Guarantee Program for Money Market Funds including the FAQ.

-- Jack Krupansky