Markets
A small but substantial change may be shaking the bond ETF infrastructure to its core. The New York State Department Financial services is allowing insurers to label bond ETFs as individual bonds rather than as equity risk. Companies have issued lots of new debt setting records as record low interest rates have made it appealing. This regulation could change the way the Fed and other regulators interact with bond markets, and could lead to the sort of efforts that saved the bond market in 2020. These will allow more bond products and increase inflows, but for insurers bond ETFs have more complications than a traditional single fixed income security and could provide difficulties in the future.
Finsum: Small changes to regulator practices like this can lead to massive swings in credit creation, keep an eye on bond ETFs.
Most fixed income ETFs used to be linked to passive tracking products in the bond market, that is until more recently. Rules Adopted by the US SEC have steered many investors to active fixed income by making it easier to launch new active ETFs. Active funds are attractive for ETF producers because they draw higher fees (about .2 percent) than active funds. This has led to an explosion in active fixed income. Active bond fund creation is growing at nearly double the rate of the rest of the ETF market, and investors are ready as well as 2021 saw a record pace of inflows. One big factor in shifting more investors into active fixed income is aging global demographics which are still searching for yield and income.
Finsum: The world’s aging population is creating a safe asset shortage and pushing bond prices higher.
The Fed hiked rates at the latest FOMC meeting but they were partially forced to with just about every measure of inflation hitting 30-year highs. However, more importantly they project that the federal funds rate will hit 2.75% by the end of 2023. This may have been the first hike in years but it will be one of eleven if they want to hit that mark. The bond market is pessimistic as they not only are projecting less hikes, but slower growth as well. The yield curve is indicating inflation will be under control but it might be costly. Typically this means that the Fed won’t mean to hike as frequently as they are indicating. There has been a lot of action in the TIPS market and it is indicating they expect inflation to average just shy of 2.8% in the next decade.
Finsum: Markets are most likely right in this scenario and that fewer rate hikes will get inflation under control; hopefully the economy can take the hit.
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February was a bad month for fixed income ETFs which saw $32.2 billion in outflows. This marks the third straight month in a row of outflows. However, fixed income wasn’t the only category suffering in February; many traditional funds like money markets and stock/mixed asset funds saw outflows as well. This is an overall bearish sentiment that is creeping across the market, and signals that investors are worried about future rate hikes for the Fed. However, alternative funds continue to be on a win streak as they had their strongest inflows in over a year and have 11 consecutive months of inflows.
Finsum: There is a stronger correlation with stocks and bonds than there was thirty years ago and many investors are turning away from bond funds in the face of volatility.
2021 was a comeback year for active fixed Exchange Traded Funds. Driving this home was a huge set of inflows as they saw a tenth of inflows globally, many of these came from the US. That trend isn’t stopping as nearly 80% of investors are searching to expand that position in 2022. Many investors see active funds having an edge with global turmoil increasing, as Russia-Ukraine escalates, and there are many macro risks domestically. Additionally, investors are clamoring to buy more ESG ETFs in 2022 as this trend shows no signs of falling off.
Finsum: Markets were messy and pretty hard to predict in the aughts, but active management seems to have a leg up in picking tech growth as well as fixed income winners.
There is nothing like an international conflict to generate a flight to safe assets, and as much pressure as treasury bond prices have taken in the last year, they are still the world’s premiere safe asset. Inflows post Russia’s invasion of Ukraine have lowered Treasury yields and raised bond prices. Additionally it appears that markets are either dubious of the Fed’s rate hikes or just don’t think it will take as many to get the jobs done. Regardless, many bond ETFs, particularly around treasuries have benefited such as the iShares 7-10 Year Treasury Bond ETF and the iShares 20+ Year Treasury Bond ETF which were up 2.0% and 2.6% respectively in the last week.
Finsum: Treasuries are still the global safe asset and they are still in short supply given the abnormally low levels of U.S. interest rates.