Fed could tip the US economy into a recession
High yield, corporate bond and emerging market debt ETFs have all seen outflows over the past month as investors look to increase the credit quality of their fixed income allocations as fears of a recession continue to ramp up.
According to data from ETFLogic, the iShares $ High Yield Corp Bond UCITS ETF has seen $833.6m outflows over the past month, the most across all ETFs listed in Europe, while investors have pulled $414.8m from the iShares € High Yield Corp Bond UCITS ETF (IHYG), as at 5 July.
Furthermore, there was a combined $651.1m outflows for the iShares Core € Corp Bond UCITS ETF (IEAC) and the iShares € Corp Bond SRI UCITS ETF (SUOE) over the same period while the iShares J.P. Morgan $ EM Bond UCITS ETF (IEMB) saw $519.9m net redemptions.
The Federal Reserve’s decision to increase interest rates by 150 basis points (bps) since it started its hiking cycle in March in a bid to tackle soaring inflation has spooked investors into believing the central bank could trigger a recession towards the end of the year.
It is forecasted the Fed could increase rates by a further 175bps in 2022 taking US rates to 3.5% by the end of the year.
As a result, spreads on more risky assets such as high yield have widened to reflect the growing concerns in the market.
Highlighting this, the spread on the Bloomberg Global High Yield Corporate Bond index has reached its widest level since July 2020, according to MarketWatch.
As Alex Brazier, deputy head of the BlackRock Investment Institute, said in a recent research note: “Central banks are facing a growth-inflation trade-off. Hiking interest rates too much risks triggering a recession, while not tightening enough risks causing unanchored inflation expectations.
“It is tough to see a perfect outcome.”
At the same time, investors have rotated into US Treasury ETFs. According to ETFLogic, the iShares $ Treasury Bond 7-10yr UCITS ETF (IBTM) has seen $1.2bn inflows over the past month while investors have piled $895.6m inflows into the Invesco US Treasury Bond 7-10 Year UCITS ETF (TREX), as at 29 June.
Wayne Nutland, head of managed index solutions at Premier Miton Investors, explained the shift in flows is the result of investor concern shifting away from inflation and towards growth risks.
“Consequently, government bond yields and inflation breakevens have declined from their recent highs but credit spreads have continued to widen, in particular for high yield and emerging market hard currency bonds,” Nutland continued.
“Credit spreads have risen to reflect the increased risk of recession, although interestingly equity earnings forecasts have not been revised down.”
For Nutland, however, this sell-off in more risky areas of fixed income could create opportunities for longer-term investors.
“With government bond yields and spreads having repriced significantly, for longer-term investors some areas of credit and emerging market debt are beginning to look attractively valued,” he added.
“Although in the near term, there could well be further downside if the much-speculated recession does emerge, if inflation does not fall and government bond yields resume their moves higher.”
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