“Higher for longer” has exchange-traded fund investors dumping short-dated debt en masse ahead of what’s widely expected to be the Federal Reserve’s last interest-rate hike.
(Bloomberg) — “Higher for longer” has exchange-traded fund investors dumping short-dated debt en masse ahead of what’s widely expected to be the Federal Reserve’s last interest-rate hike.
Nearly $3.5 billion has exited from funds holding bonds maturing in one to three years so far in July, Bloomberg Intelligence data show. That’s on track to be the second-largest outflow in data going back to 2016, behind June’s $4.1 billion exodus.
Appetite for the front-end of the Treasury yield curve has cooled amid one of the most aggressive Fed tightening campaigns in history. While traders widely expect this week’s hike to be the final in this cycle, the prospect that policymakers will then hold interest rates steady for an extended period will keep two-year Treasury yields elevated, according to Societe Generale’s Subadra Rajappa. At the same time, wagers on 2023 rate cuts have been pushed out.
“Pricing out cuts for this year and pricing in hikes and higher for longer is pushing two-year yields higher,” said Rajappa, head of US interest-rate strategy at Societe Generale SA. “If the Fed remains on hold until 2025, then the two-year Treasury yield should be higher.”
Yields on two-year Treasuries are currently hovering near 4.88%, after entering 2023 closer to 4.4%. That compares to 1.34% at the start of March 2022 before the Fed rate-hike campaign, which would see the central bank deliver 500 basis points of rate increases to combat the hottest inflation in a generation.
While demand for short-duration debt has ebbed, money managers continue to pile into the very front-end of the market. ETFs tracking debt maturing in a year or less have absorbed nearly $4 billion so far this month, while assets in money-market funds is hovering near record levels.
Given the deep inversion of the yield curve — meaning that shorter duration debt offers higher yields than longer-dated securities — it’s reasonable to see a continued bid for cash, according to BlackRock’s Rick Rieder.
“You can own commercial paper — that six-month, nine-month commercial paper and clip over 6% yield, which is pretty incredible,” BlackRock global fixed income chief investment officer Rieder said on Bloomberg Television’s ETF IQ. “With an inverted curve, to sit in some of these areas that are not paying a lot doesn’t make a lot of sense.”
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