Why Investors Are Dumping Junk Bond ETFs

Junk bond ETFs have been suffering lately as investors in the United States have been escaping the high-risk segments of the domestic debt markets. Moreover, recent fund flows show the shift in sentiment among investors and how they are adapting to changing circumstances.

What’s Driving the ETFs?

U.S. markets recently suffered a sell-off owing to fears of rising rates. The S&P 500 entered correction territory, as it declined more than 10% from the record high set in January. Strong wage growth and jobs data introduced fears that inflationary pressures will cause bond yields to creep up and force policymakers to hike rates.

Per the latest inflation data, consumer prices increased 2.1% year over year in January, unchanged from the previous month but above economists’ forecast of 1.9%. Moreover, President Donald Trump’s tax reform and spending deal might add further pressure to prices. In the long term, Trump’s potential $1 trillion infrastructure bill and the economy reaching full employment might lead to a change in the newly elected Jerome Powell’s plans to a more aggressive stance (read: Are TIPS ETFs the New Safe Haven?).  

Following the release, U.S. 10-year treasury yields edged up to a four-year high of 2.92%, as latest trends in the U.S. economic space drove investor sentiment.Moving on to monetary policy, the Fed is expected to hike interest rates multiple times this year to tame inflation. Given this, markets are betting on the Fed to hike rates more than the three times suggested earlier. Per the CME Fed Watch tool, there is a 71.9% chance of a 25 basis point rate hike in March.

Changing Circumstances

The recent turmoil in the markets has been strongly weighing on investors’ risk appetite and making them reallocate their portfolios. “It’s hard to think of elevated volatility in both rates and equity not eventually seeping into credit,” Henry Peabody of Eaton Vance Corp said, per a Bloomberg article. He added “Investors are waiting for the markets to settle down.”