As with stocks and other investments, rates in the money market world tend to rise as risk increases. So ultra-safe money market funds that hold only Treasury debt have extremely low yields -- around 1.5% to 1.7%. Higher-yielding money market funds that hold corporate debt pay a bit more -- around 2.3%.
Those small differences in rates make plenty of sense -- in a tight credit environment, corporate issuers have to pay a premium to get investors to own their debt. But where traditional rate relationships have broken down is in the tax-exempt municipal money market. Although you might consider state and local governments to be no riskier than corporate issuers, the rates governments are having to pay for short-term borrowing have gone sky-high -- above 5% as of yesterday.
When you consider that interest on tax-exempt municipals is free from federal income tax, making that 5% equivalent to nearly 7.7% in a taxable investment for someone in the 35% tax bracket, you can see that things don't make sense right now. Are munis a great opportunity, or the latest value trap?
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