Bond ETF Flows Signaling Fed Rate Hike

For those who believe ETF flows can tell investors a lot of what they need to know about markets these days, it's safe to wager the economy is on the mend and the Federal Reserve is likely to raise short-term interest rates before long.

With employment figures continuing to improve in the U.S., it looks like a big institutional investor or a number of smaller ones are exiting a lot of bond fund positions. The U.S. government's most recent nonfarm payrolls report showing the economy generated almost 300,000 new jobs in February really got the market believing.

That said, many of the bond outflows occurred before the data came out, according to data we compile. In the week ended last Friday, March 6—which includes the market's reaction to the latest jobs data, more than $3.5 billion worth of outflows from over a half-dozen iShares bond ETFs suggest change is coming, or at least these investors believe so.

Outflows Across The Curve

The redemptions span the Treasurys yield curve and included aggregate bond funds and high-yield funds as well.

When rates go higher or threaten to go higher, bond prices will move, raising the risk of capital losses for holders of perpetual bond funds that don't ever mature. These are the type of capital flows that hedge funds pore over to discern important patterns, and in the world of ETFs, we get to digest these developments right away.

The table below, spanning the past market week—Friday, Feb. 27 to Friday, March 6—shows the outflows. Some funds bled more than 10 percent of their assets. Just where the money is going isn't yet clear, but we'll be watching closely in the coming days.

Prices Already Moving

The longer-dated the paper, the more sensitive a given bond or bond fund's price will move. So it is that the iShares 20+ Year Treasury Bond ETF (TLT | A-85)—the red line in the chart below—is the fund whose price has been hit the hardest. (It also climbed the most when there was downward pressure on bond yields last year and in the early weeks of 2015.) TLT's price has fallen almost 1 percent this year and almost 5 percent in the past month.

On the opposite side of the yield curve, the short-dated iShares Short Treasury Bond ETF (SHV | A-96) hasn't moved at all. It's like a bank account chock full of risk-free Treasurys. But the trade-off is that the paltry yield coming off a fixed-income fund like SHV isn't enough to offset the rate of inflation.

Chart courtesy of StockCharts.com

Outflows From The Belly And Beyond

Some of the heftiest outflows—as a percentage of total assets in the funds—were from bond funds that cover the intermediate-dated debt—the so-called belly of the yield curve.

For example, the iShares 3-7 Year Treasury Bond ETF (IEI | A-71) lost $835 million in the past week to redemptions, or more than 15 percent of the assets in the fund. Also, the iShares 7-10 Year Treasury Bond ETF (IEF | A-51) dropped more than $1 billion to outflows, or more than 10 percent of all the assets in the fund.

Even core holdings such as the iShares Core U.S. Aggregate Bond ETF (AGG | A-98) were caught in the apparent reallocation, as were junk bond funds like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-64) that reach for yield by taking on extra credit risk.

As a final note, it's no fluke that every last one of these funds is sponsored by San Francisco-based iShares. It is, after all, the world's biggest ETF firm and its deep and broad lineup of exchange-traded funds at times makes iShares a decent metaphor for the transparency of the entire ETF industry.

At the time this article was written, the author held no positions in the securities mentioned. Contact Olly Ludwig at [email protected] or follow him on Twitter @OllyLudwig.