What Bond ETFs Are Saying About Rates

The Federal Reserve commences its final meeting of 2016 Tuesday, and bond markets are implying an interest rate hike of at least 25 basis points is essentially a foregone conclusion. The Fed has not boosted borrowing costs since December 2015.

November was unkind to bonds and fixed-income exchange-traded funds. In fact, data suggest short sellers eagerly targeted bond funds last month. Two bond ETFs remain among this year's top 10 asset-gathering ETFs, but that's well below the peak seen earlier this year when as many as five or six of the 10 best asset-gathering ETFs were bond funds.

Fed Confidence And Investor Reactions

Perhaps, investors are overreacting to the specter of a Fed rate hike. After all, it can be taken as a sign the Fed is confident in the strength of the U.S. economy.

“This potential increase in short-term interest rates probably won’t have much of an impact on most fixed income portfolios,” said BlackRock in a recent note. “The forecasted move itself is small, and it mostly affects shorter maturity bonds that do not have as much interest rate sensitivity as longer maturity bonds.”

A Look Back From November 2

Since the last Fed meeting on November 2, some segments of the bond ETF universe have been drubbed by outflows, but those outflows are not universal. Not surprisingly, BlackRock data indicate Treasury and emerging markets bond funds have lost money over that period. 

The iShares JPMorgan USD Emer Mkt Bnd Fd ETF EMB spent considerable time as one of this year's top asset-gathering ETFs, but it has been pinched by the rising dollar. The case for the dollar-denominated debt held by EMB and rival ETFs is bolstered in the a “lower for longer” environment, because emerging market bonds denominated in dollars have previously proven sensitive to rising Treasury yields.

Treasury Focus, High-Yield Inflows

“As Treasury rates have risen, investors have pulled back from Treasury securities. At the same time some have moved into TIPs on the expectation of higher inflation. And high yield inflows have been strong on the belief that that sector will continue to perform well. Like EM equities, EM bonds have experienced outflows and poor performance due to concerns about the impact of potentially new U.S. trade policies on emerging economies,” added BlackRock.

Often seen as vulnerable to higher interest rates, high-yield corporate bond ETFs have been impressive asset gatherers since the November Fed meeting. For example, the iShares iBoxx $ High Yid Corp Bond (ETF) HYG, the largest high-yield corporate bond ETF, has added $1.66 billion in new assets over that period.