Despite signaling a potential interest rate hike for December, the Federal Reserve’s overtures fell on deaf ears in the fixed-income market, with junk bond exchange traded funds largely ignoring the rate risks.
Over the past week, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) remained largely flat. However, after the Federal Open Market Committee announcement on Wednesday, investment-grade corporate and government debt retreated, with the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) down 1.3% and iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) 1.2% lower.
Additionally, ETF investors were relatively unfazed by the Fed’s hints. Over the past four trading sessions, junk bond ETFs continued to attract assets, with HYG bringing in $443.1 million in net inflows and JNK attracting $172.7 million, according to ETF.com. [Investors Dive Back Into Junk Bond ETFs]
Reflecting skepticism with the Fed’s December outlook, Fed funds futures indicate traders only see about a 50% chance of an interest rate hike from the current near-zero levels in December, and overnight index swaps show a 45% probability of a December hike, reports Alexandra Scaggs for Bloomberg.
Jim Bianco, president of Bianco Research LLC, argues that a 60% reading would reflect a market that is more prepared for a December move.
While the 50% indicated by futures “may seem like a coin flip, the market is unwilling to give the Fed approval just yet,” Bianco said. “The implied odds would need to be closer to 60 percent for this to be the case. The Fed will not move without the market’s permission.”
Many traders have also priced out a Fed move this year after the recent weaker-than-expected U.S. job creation and retail sails numbers.
The Fed has also hesitated on pulling the trigger due to the ongoing volatility, notably in overseas markets.
Moreover, even if the Fed makes a move, bond traders are skeptical that rates will rise as quickly as policy makers hope – Fed officials have a median projection for borrowing costs to rise 1.4% next year and 3.5% over the long-term while futures suggest traders anticipate a 0.72% rise by the end of 2016 and 1.56% over the next three years.
iShares iBoxx $ High Yield Corporate Bond ETF
For more information on the speculative-grade bond market, visit our junk bonds category.
Max Chen contributed to this article.