A big change in how the Federal Reserve plans to raise interest rates has caused an outflow from credit exchange-traded funds that has never happened before.
Last month, three of the most popular corporate bond ETFs lost a total of $11.9 billion. The iShares iBoxx High Yield Corporate Bond ETF, which is worth $12.8 billion, lost a record $4.9 billion (ticker HYG). According to data collected by Bloomberg, the $33 billion iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the $7.4 billion SPDR Bloomberg High Yield Bond ETF (JNK) also had their biggest monthly withdrawals ever.
Fixed-income markets of all kinds were shaken up in February as investors changed how they thought the Fed would fight inflation. Treasury yields are at their highest level in more than a month because inflation is still going strong. Traders are getting ready for the possibility that the central bank will set rates higher than they thought before. Even so, spreads on both investment-grade and high-yield debt are still a lot lower than they were at their highest point last year. This suggests that there will be more pain in the future.
“The two drivers of return — the risk-free rate and the spread — are both probably still too low for the environment we’re in, one where growth and inflation remain too hot and the Fed may have to go further,” Sameer Samana, Wells Fargo Investment Institute senior global market strategist, said. “So, the next meaningful move for spreads is probably higher.”
The current pricing on the markets indicates that the Fed’s main rate will peak at approximately 5.5% in September, but other investors are betting that the benchmark interest rate will approach 6%. Traders were skeptical a month ago that the central bank would raise rates to 5% as part of its effort to hike rates.
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In February, as a result of the sudden shift in perspective, both HYG and JNK experienced losses of approximately 2.4%, the largest monthly loss since December. The performance of blue-chip debt was much worse, with LQD declining 4.5%, marking its worst showing since September.
When investors pulled money out of ETFs that invest in corporate bonds, demand was robust for funds that behaved similarly to cash. During the month of February, more than $4.5 billion was deposited into the iShares Short Treasury Bond ETF (ticker SHV), making it the month with the largest monthly inflow in the fund’s entire 16-year history.
Mona Mahajan, Edward Jones senior investment strategist, said on Bloomberg Television-
“What’s notably different this cycle is that cash and cash-like instruments are yielding anywhere from 4% to 5% plus”
“If investors do want to hang out, think about a recovery playbook but in the meanwhile put money in very attractively yielding assets, that’s a place where we’re seeing a lot of defense now.”
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