By Christine Idzelis
Happy Thursday! Investors have been focused on the recession signal sent by the U.S. bond market this week as the Federal Reserve aims to fight high inflation through interest rate hikes this year.
For this week’s ETF Wrap, we spoke with Harley Bassman, managing partner at Simplify Asset Management, and Vanguard Group’s John Madziyire, who is a senior portfolio manager and head of U.S. Treasuries and inflation within the firm’s fixed-income group, about the debt markets and where investors might consider putting money to work against the backdrop of rising rates.
We also take a look at last week’s high-yield ETF outflows, and why they made Jefferies equity strategist Steven DeSanctis “a little nervous.”
The $3.2 billion of withdrawals from high-yield ETFs last week are a “big concern,” according to a Jefferies research report dated March 26. The outflows, including from the iShares iBoxx $ High Yield Corporate Bond ETF /zigman2/quotes/204471305/composite HYG +0.89% and SPDR Bloomberg High Yield Bond ETF /zigman2/quotes/202941311/composite JNK +0.92% , amounted to 13.2% of the category’s asset base, the report shows.
“It makes me a little nervous,” said Steven DeSanctis, equity strategist at Jefferies, in a phone interview. While high-yield ETFs have seen “pretty significant” outflows this year, “this one was notably chunky,” he said, adding that the bulk of the withdrawals were from iShares iBoxx $ High Yield Corporate Bond ETF /zigman2/quotes/204471305/composite HYG +0.89% .
DeSanctis said he worries that selling pressure in the high-yield market could lead to wider credit spreads, which he monitors as a gauge of investors’ risk appetite.
High-yield spreads can tell investors “whether or not there’s trust in the credit market,” and soured sentiment in the junk bond market can spill over into the equity market, said DeSanctis. When companies borrow in the bond market, they pay a spread over comparable Treasuries, with riskier, junk-rated businesses facing higher borrowing costs.
The $3.2 billion of outflows from high-yield bonds ETFs in the week through March 25 didn’t lead to wider spreads, though, according to DeSanctis. “It’s a little peculiar because spreads actually narrowed over the course of the week, thankfully,” he said, adding that the tightening of spreads came as market volatility subsided last week.
But high-yield bond spreads have widened a bit since the start of 2022. They were 3.33 percentage points over comparable Treasurys on March 30, compared with 3.05 percentage points on Jan. 3, according to ICE BofA US High Yield Index Option-Adjusted Spread data tracked on the website of the Federal Reserve Bank of St. Louis .
During economic downturns in particular, investors watch for signs of stress in the high-yield market because companies with high levels of debt relative to their cash flows are more vulnerable, said DeSanctis. Meanwhile, the U.S. economy is “ very strong ,” and can handle tighter monetary policy, said Federal Reserve Chair Jerome Powell during his March 16 press conference. But growth is expected to slow against the backdrop of high inflation that the Fed aims to fight through rate hikes.
The U.S. Treasury market this week flashed a recession warning, with 2-year yields briefly exceeding 10-year yields in a so-called i nversion of that portion of the yield curve for the first time since 2019 .
“The Treasury market is flashing a very bright yellow light about caution about the economy,” said Harley Bassman, managing partner at Simplify Asset Management, in a phone interview. “You have not seen that caution flow through to the corporate bond market or to the equity market—yet,” he said.
The S&P 500 index recently exited correction territory and is trading not far off its all-time high. The S&P 500 /zigman2/quotes/210599714/realtime SPX +1.73% fell Wednesday, snapping a four-day winning streak, to close about 4% off its record close of 4796.56 on January 3. The SPDR S&P 500 ETF Trust /zigman2/quotes/209901640/composite SPY +1.69% was trading down modestly Thursday afternoon, according to FactSet data, at last check.
Meanwhile, shares of the iShares iBoxx $ High Yield Corporate Bond ETF /zigman2/quotes/204471305/composite HYG +0.89% were down about 0.1% Thursday afternoon and have fallen around 5% this year, FactSet data show, at last check. Shares of the SPDR Bloomberg High Yield Bond ETF /zigman2/quotes/202941311/composite JNK +0.92% were similarly down this afternoon and so far in 2022.