June 8, 2018

Bond Fund Investors Continue to Bet on Additional Rate Hikes

by Tom Roseen.

Mutual funds and ETF investors have continued to bet that there will be additional interest rate hikes by the Federal Reserve Board this year. Looking at weekly flow trends, fund investors continued to pad the coffers of Thomson Reuters Lipper’s Loan Participation Funds (aka leveraged loan funds or bank loan funds) classification for a sixteenth consecutive week, injecting $417 million for the fund-flows week ended June 6, 2018. Year to date, Loan Participation Funds attracted a net $11.0 billion, almost matching the total net inflows seen for 2017 (+$12.5 billion).

Loan participation funds are also referred to as floating-rate funds because the underlying loans typically pay interest based on a floating rate (often the London Interbank Offering Rate—LIBOR). The floating-rate feature adjusts with changing market conditions, and these funds are often seen as being more stable than a typical bond fund in a rising-interest-rate environment, despite typically being rated as below-investment-grade debt and carrying greater credit risk.

On the other hand, fund investors appear to be slightly less convinced that inflation will be rearing its ugly head in any significant way in the near future. While investors injected net new money into Lipper’s Inflation-Protected Bond Funds classification (+$909 million) for the most recent fund-flows week for the first week in three, for the year to date inflation-protected bond funds have attracted just $6.6 billion, a little over one-third of the net inflows seen for 2017 (+$17.4 billion).

Nonetheless, despite the ten-year Treasury yield at least temporarily jumping above the 3% mark in May and with market participants pricing in a 91% probability the Fed will hike its key short-term lending rate an additional 25 basis points at its June 13-14 FOMC meeting (according to the CME Group FedWatch Tool), investors continued to be net purchasers of Core Bond Funds, injecting net new money into the classification for the third week in four (this past week only to the tune of $11 million). That brought the year-to-date net inflows for the classification to $32.7 billion.

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