Investors have been fleeing the high yield bond market — where the riskiest corporates borrow cash — over the last two weeks. Money managers are closely watching asset flows for signs that the loose money available to U.S. companies could start to tighten.
Why it matters: The Federal Reserve is in the early stages of removing stimulus, and investors' reshuffling around a new normal is just beginning. Chair Jerome Powell amped up expectations for earlier rate hikes last week when he said that the Fed could speed up the tapering of bond purchases — a prerequisite to liftoff.
- A rising rate environment pushes up companies' costs to borrow, which pressures the prices of existing corporate bonds as they become less attractive.
By the numbers: Last week, high yield mutual funds and ETFs experienced a net outflow of $4.2 billion, following a $1.1 billion outflow the week before, according to EPFR. That’s after an average of about $1 billion in inflows each prior week this year.
- Returns went negative for the first time this year in the month of October. And just since Nov. 8 — on the heels of hotter than expected inflation and jobs numbers — the ICE BofA high yield index returned a negative 1.5%.
“When you have inflection points in Fed policy, you see volatility in risk assets,” says Bill Zox, high yield portfolio manager at Brandywine Global.
The big picture: High yield may be yielding nearly a percentage point more than it was in September — but the recent exodus hasn't catapulted yields back up to historical norms just yet.
What we're watching: Whether the slow but steady selloff over the last few months marks the beginning of a return to more normalized yields — or if high yield remains attractive enough relative to other low-yielding asset classes around the world that investors opt to buy the dip, or at least stay the course.
- “I don't read anything into this as the beginning of the end for high yield. I don't think we're anywhere close to that point,” Zox says, noting that default rates remain exceedingly low, which indicates strong corporate balance sheets.
- And data shows that in the seven most recent periods of rising rates, total returns on the high yield index have been positive, according to a November research note by Insight Investment.