With the Q1 earnings season slowly coming to an end, investors have turned their attention back to the Federal Reserve Board’s fiscal policies, the political standoff over the debt ceiling, and economic data—keeping market participants on their toes.
During the LSEG Lipper fund-flows week ended May 17, 2023, investors took their collective foot off the pedal, selectively padding the coffers of money market funds (+$10.4 billion) and taxable fixed income funds (including ETFs) while being net redeemers of equity funds (-$7.0 billion) and tax-exempt fixed income funds (-$187 million). Meanwhile, investors took a wait-and-see approach to investing ahead of a few high-profile deadlines.
Investors became slightly more risk averse for the week after Treasury Secretary Janet Yellen reiterated her concerns that the U.S. may not be able to pay all its bills as early as June 1 if the debt ceiling is not increased. And even though President Joe Biden told reporters on Monday, May 15, that he remains optimistic and “there is a desire on their part as well as ours to reach an agreement,” House Speaker Kevin McCarthy said Congressional Republicans remained “far apart,” adding to the overall market angst.
During the week, Fed officials sent mixed messages over their views on whether the central bank should pause or continue to hike rates until its inflation target is reached. Keeping investors on guard, Minneapolis Fed President Neel Kashkari said he’d support more interest rate hikes from the Fed until inflation returns to the central bank’s 2% target—contrary to Fed Chair Jerome Powell’s hint that the Fed might be able to pause its interest-rate hike campaign after its most recent interest rate hike at the beginning of May.
These mixed messages cast a pall of uncertainty over the markets.
While the average equity fund (including ETFs) posted a 0.28% return for the week ended May 17, investors were net redeemers of equity funds, withdrawing a net $7.0 billion. Conventional equity funds witnessed net outflows of $3.7 billion, while their ETF counterparts handed back $3.4 billion.
However, the opposite was true on the bond side of the equation. While the average taxable fixed income fund (including ETFs) suffered a 0.60% market loss for the flows week, investors injected $1.3 billion into taxable fixed income funds, despite concerns of another central bank interest rate hike during its next policy-setting committee meeting set for June 13-14. However, according to the CME FedWatch tool, Fed funds futures traders now see an 85.5% likelihood that the Fed will keep its key lending rate at its current range between 5.00% and 5.25% next month. For the most recent fund-flows week, conventional taxable bond funds experienced net redemptions to the tune of $1.1 billion, while taxable bond ETFs attracted $2.4 billion.
As we can see in the yield curve below, the short end of the curve has seen a significant rise perhaps in sympathy with both the possibility of a government default in the short term (although, thought of as being very unlikely) and the possibility that inflation data might be too strong for the Fed to become more dovish.
That said, investors avoided the short-term and lower quality taxable fixed income classifications and macro-groups, withdrawing some $1.2 billion from high-yield bond funds (including ETFs), while injecting net new money into corporate investment-grade debt funds (+$2.2 billion) and government-Treasury funds (+$387 million).
For the fund-flows week, iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD, +$1.1 billion), Schwab Short Term US Treasury ETF (SCHO, +$967 million), and iShares 1-3 Year Treasury Bond ETF (SHY, +$713 million) attracted the largest amounts of net new money of all individual taxable fixed income ETFs. Meanwhile, iShares Short Treasury Bond ETF (SHV, -$3.0 billion) and iShares iBoxx $ High Yield Corporate Bond ETF (HYG, -$645 million) handed back the largest individual net redemptions for the week.
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