The Federal Reserve’s decision to hike interest rates to tackle skyrocketing inflation is driving investors into short-duration bond ETFs.

According to data from ETFLogic, the iShares $ Treasury Bond 3-7yr UCITS ETF (CBU7) has seen $1.4bn inflows over the past month, as at 18 May, the second-highest across all European-listed ETFs.

Meanwhile, the iShares $ Short Duration Corp Bond UCITS ETF (SDIA) saw $334m new assets over the same period while investors piled $301m into the iShares $ Treasury Bond 1-3yr UCITS ETF (IBTS).

Furthermore, volumes have surged across fixed income ETFs in Europe in recent times. According to BlackRock, daily traded volumes in April averaged $3.7bn versus $2.8bn for the entire 2021, a 32% increase.

Brett Olson, head of fixed income iShares EMEA at BlackRock, said the shift to short-duration bond ETFs clearly indicates a flight to safety from investors looking to protect themselves from rising interest rates.

Earlier this month, the Fed hiked rates by 50 basis points to a range of 0.75% to 1%, its fastest increase since 2000, in a bid to quell inflation which has jumped to 8.5% in the US.

“Asset managers, in particular, are using ETFs as vehicles to rotate within fixed income asset classes,” Olson continued. “Historically, the trend was a rotation into cash but now investors are moving from exposures like high yield directly into govies.”

On the outlook for inflation, Vincent Deluard, global macro strategist at StoneX, predicted this Consumer Price Index (CPI) reading will be the peak, however, cautioned that structural inflation is starting to accelerate.

“Inflation should slow to 5.5%-6% by the end of the year, but the Fed – and most big banks – have promised a faster drop to about 4.3%,” Deluard continued. “[Investors should] brace for inflation surprises, even as inflation slows.”

Furthermore, he predicted the next leg of this bear market would be triggered by September’s CPI release – which will surprise to the upside – as investors “realise in horror that the Fed will not be able to ease in mid-2023, as is currently priced by the rates market”.

The Fed is currently walking a tightrope with concerns too many rate increases will cut off any chance of growth in the US economy.

For Richard Carter, head of fixed interest research at Quilter Cheviot, it is likely markets will continue to see increased volatility as long as inflation remains a problem for central banks.

“The Fed is likely to push rates up towards the 3% level by year-end provided they are not blown off courses by events such as the war in Ukraine,” he added. “The market has been well prepared for these moves but that does not mean they will necessarily take them well.”

In response to the uncertainty, ultrashort-duration bond ETFs have been some of the best-performing assets over the months with the iShares $ Ultrashort Bond UCITS ETF (ERNU) leading the way with returns of 10.6%, as at 18 May.

This has been followed by other ETFs offering exposure to the short-end of the US Treasury yield curve including the iShares $ Treasury Bond 0-1yr UCITS ETF (IB01) and the JPMorgan BetaBuilders US Treasury 0-3 Months UCITS ETF (BB3M) which both returned 6.56%.

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