US bond investors increased their exposure to the riskiest end of the bond market in the week leading up to the Fed's first decision in four meetings.
The upcoming Fed Open Market Committee meeting on Thursday was hotly tipped as the defining moment, which would see the US start to raise interest rates from historical lows. The narrative has been thrown a curve ball in recent weeks with many now questioning the wisdom of raising interest rates in the wake of recent emerging market weakness.
The Markit Emerging Market PMI indicated that these markets have experienced their worst patch since the global financial crisis in 2008, raising questions about the Fed's willingness to raise interest rates before the impact of emerging market weakness to US growth is better understood.
This uncertainty is also reflected in US treasury yields with the Markit iBoxx $ Treasuries index now trading 20bps off the levels seen earlier in the summer when the consensus for a September rate rise was much stronger.
ETF investors add to HY exposure
US ETF investors have increased their exposure to high yield bonds in the week prior to this week's FOMC meeting, offering another indication of the market's lack of belief in a September rate hike. This relatively strong appetite for high yield bonds saw investors pile $450m of funds into the 28 US listed domestically exposed ETFs.
This was not the case in the four previous meetings as investors were weary of being exposed to the most volatile end of the US bond market, which would arguably feel the brunt of any hawkish Fed policy moves.
Outflows avoid losses
This desire to avoid high yield bonds in the lead up to the FOMC decision has paid out so far this year as the Markit iBoxx $ Liquid High Yield index has delivered negative total returns in the subsequent week during four of the last five meetings.
This underperformance averages out to a significant -0.4%, making the inflows witnessed over the last week even more significant given the large negative swings in the asset class over the last five meetings.
Already priced in?
The bull case for the asset class can also be made given the fact that the yields of high yield corporate bonds are at three-year highs after climbing 1.6% in the last 12 months.
While a large part of the recent yield spike has been driven by increased risk perceptions of energy and mining issuers, a portion of this trend can surely be attributed to investors taking the Fed's forward guidance on interest rates to heart.