Bull Market For Bond ETFs Coming To An End?

Includes: LQD, TLT, USO
by: Zacks Funds

As risk appetite returned at the start of Q2, chances of the bull run in the bond market falling flat rose. The start of 2016 was awesome for the fixed-income market as China-led global market worries and the 12-year plunge in oil prices stirred up global market quandaries and people rushed to safe refuge bond ETFs.

In fact, the impact of the global financial market turmoil was so deep-rooted that the Fed halved its number of rate hike estimates for 2016 from four to two in its March meeting. Also, Fed chair Yellen reaffirmed the 'cautious' stance on future policy tightening. Needless to say, the very move dragged down the U.S. benchmark bond yields and pushed up prices.

However, all the optimism is fleeting away with an uptick in bond yields. Agreed, the yield on 10-year U.S. Treasury is yet to reach the 2% mark in April (as of April 25, 2016), but it has exhibited an uptrend lately. Yields on 10-year U.S. Treasury rose 15 bps in a short span - from April 15 to April 25.

Not only the U.S., even the German market saw the same trend. "The 10-year German government bond yield logged the largest weekly increase in yield since December," as per Wall Street Journal. With these, the government bonds in the U.S. and Germany recorded "their biggest weekly selloffs of 2016." Wall Street Journal also noted, "A gauge of inflation expectations in the U.S. bond market reached the highest level since August 2015" on April 22.

What's Behind This Trend Reversal?

As indicated earlier, signs of a great rotation or a shift from bonds to stocks are palpable. The reason for this is an improving outlook on economic growth and global inflation, as per analysts.

And why not? After all, commodities are off to a great start this year on a softer greenback and the key 'oil' has gained a measure of stability. United States Oil (NYSEARCA:USO) added about 17.6% in the last three months (as of April 25, 2016).

Plus, ECB president Mario Draghi's prediction that price growth in the Eurozone will likely gain momentum in the second half of 2016, also led to rising expectations of global inflation. On the other hand, China - one of the root causes of the global market rout in recent times - is giving positive cues on the economic improvement front. This should prompt the Fed to raise rates this year, though at a moderate pace. All in all, rising bets over economic growth are punishing bonds.

Investors should note that the ultra-popular bond ETF iShares 20+ Year Treasury Bond (NYSEARCA:TLT) shed 556.5 million in assets in the week April 22, 2016. There was only one bond ETF - iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD) with a relatively higher yield - in the top 10 asset gatherers' list. The fund generated about $214.2 million in assets in the week under consideration.

Road Ahead

Like many other analysts, we definitely do not believe that this waning trend in the fixed-income market will last long. After all, the global economy including the U.S. has to go a long way to see the bears totally beating out the bulls in the bond market.

After all, IMF slashed global growth forecasts recently and reduced the U.S. growth forecast for the year from 2.6% to 2.4%. U.S. consumer prices rose 0.9% year over year in March 2016, which was lower than 1% recorded in the previous month as well as market expectations of a 1.1% rise. Regions like Eurozone and Japan are yet to witness a full-fledged recovery on the inflation front.

Analysts noted that "in three of the last four years, bond prices have fallen sharply to start the year, only to surge later as economic and geopolitical concerns took over investors' minds." So, bond investors should not be unnerved by the latest sell-off in the space.

Instead, they should remember that yields on U.S. 10-year treasuries are still below the 2% mark. What is happening currently is just the result of a return of risk-on sentiments after a subdued Q1.

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