Investors pulled assets out of floating rate bond ETFs last week amid bets the Federal Reserve will start cutting rates by the end of the year.
According to data from ETFLogic, the iShares $ Floating Rate Bond UCITS ETF saw $201m outflows in the week to 23 March while the Amundi Floating Rate Corporate ESG UCITS ETF (AFLE) posted $83m outflows over the same period.
The inflows come amid market expectations the Fed could start cutting interest rates as early as July despite repeated calls from chair Jerome Powell the central bank has no such plans.
Floating rate bonds, whose payments adjust to reflect changes in interest rates, outperform when rates are rising but underperform in lower-rate environments.
According to the CME FedWatch Tool, markets are forecasting a 34.7% chance the Fed will cut rates by 25 basis points (bps) in July’s Federal Open Market Committee (FOMC) meeting while there is only a 7.3% chance the Fed will not lower rates by the end of the year.
This is in stark contrast to the Fed’s messaging so far this year including Powell’s comments last Wednesday where the central bank delivered a 25bps hike.
“Given our outlook, I just do not see us cutting rates this year,” Powell said.
Powell’s views are echoed by the world’s largest asset manager BlackRock which does not expect the Fed to cut interest rates in 2023 either.
“We do not see rate cuts this year – that is the old playbook when central banks would rush to rescue the economy as a recession hit,” the BlackRock Investment Institute said. “Now they are causing the recession to fight sticky inflation – and that makes rate cuts unlikely.”
BlackRock warned inflation is likely to remain stickier in the US than market expectations which makes inflation-linked bonds and short-duration US Treasuries attractive.
The ongoing banking crisis – and the further risk of contagion – is the key driver behind the market’s expectations with Deutsche Bank’s share price the latest wobble in the sector.
Concerns started earlier this month following the collapse of Silicon Valley Bank in the US before risks spread to Credit Suisse which was forced to be bailed out by Swiss rival UBS in a $3.25bn deal.
David Goebel, associate director of investment strategy at Evelyn Partners, said the turmoil in the banking sector is not enough for a significant change of course from the Fed.
He said the wealth manager is looking to increase duration across government bonds as the Fed comes closer to the end of its hiking cycle.