There’s no question—with interest rates rising, inflation persisting, and volatility reigning, it’s been a challenging year for fixed income. In such an uncertain market environment, insights into investors’ mindsets are worth their weight in gold, as they offer a possible answer to the critical question—where are we heading?
Enter ETF flows.
An examination of the money that is being invested in—or taken out of—fixed income ETFs reveals certain trends, which teach us great deal about the market’s expectations. From macroeconomic outlook to potential investment opportunities—these insights and more can be found in the data, as long as you know where to look.
Trend #1: Weathering aggressive rate hikes with three key themes
Investment-grade credit offers investors a chance to move up the credit curve and make their portfolio more quality-based, which is attractive in an uncertain market environment.
Trend #2: Protecting against inflation with TIPS and infrastructure
Trend #3: Finding opportunities in an inverted yield curve
We’re still in a volatile environment, and though one-year expected inflation has declined from 6% to below 2%, there is no guarantee that we won’t see more inflation-related surprises in the near term.
Trend #4: Looking backward to see forward
Current ETF flows tell us a great deal about the market’s mindset. But historical flows can also be valuable as a record of how markets have reacted to past situations—and how things may play out going forward. In past recessions, we’ve often seen a flight to Quality trade and greater interest in long duration, especially long federal bonds in Canada and long treasuries in the
U.S. From a credit perspective, we’ve seen investors looking to move up the credit curve and take some High Yield and BBB risk off the table; elevated yields give investors flexibility, as they’re able to meet their income needs with high-quality, investment grade credit. All of these historical impulses are in line with conversations being had and trends starting to emerge in recent ETF flows. Looking at the big picture, one important thing to keep in mind is that periods of higher interest rates tend to last longer than markets expect. Often, investors’ outlook is overly rosy, expecting central banks to quickly reverse course and cut rates as soon as they’re done raising them. But historically, the Fed and the Bank of Canada usually prefer to keep their policy stable for several meetings, and sometimes several quarters, which allows the economy to slow down a bit before revving back up again. For that reason, investors may consider waiting to add long duration to their portfolio. With yields as high as they are, it may be preferable to be late to that trade than to be too early.
BMO’s fixed income ETF solutions
Institutional investors seeking to capitalize on some of these trends may wish to consider the following BMO ETF solutions:
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