Overview: The week in corporate bonds—the rate hike (Part 9 of 9)

Must-know: Analyzing flows in bond mutual funds

Analyzing the flow patterns in bond mutual funds

Last week saw substantial withdrawals from both investment-grade (LQD ) and leveraged loan (BKLN ) mutual funds to the tune of $650.1 million for the week ending June 11 and $1.2 billion for the week ending June 13, respectively. However, high-yield bond funds reported net inflows amounting to $277 million—the sixth consecutive week of inflows (source: Lipper).

From the analysis in the previous sections, a few key trends are apparent:

Investors expected the low rates environment to persist—a view that was reinforced at the June Federal Open Market Committee (or FOMC) meeting (refer to Part 2 of this series). Investors probably piled into high-yield debt (JNK ) funds looking for higher yields.

Due to the low rates environment, investors continued to exit leveraged loan funds, as these pay interest on floating rate basis. The outlook for lower rates is likely to adversely impact future flows into these funds, at least in the near term.

Investment-grade issuers showed a distinct preference for fixed-rate debt, as they look to lock-in rates that are at extremely low levels.

The Fed’s June FOMC was the elephant in the room last week

Investor expectations about the June FOMC, was probably also a factor influencing fund outflows from investment-grade mutual funds. Secondary market flows in bond mutual funds invariably follow the interest rate expectations of investors. Rising interest rates mean a fall in bond prices and vice-versa. A change in the interest rates path of the Fed funds rate as disclosed by the Fed’s “dots” would impact interest rate expectations.

Investors were probably cautious ahead of the Fed’s FOMC, due to positive economic reports from the manufacturing sector and improvements in the labor market that released in the prior week. On the heels of these reports, the S&P 500 Index (SPY ) increased to a record high of 1951.27, reached on Monday, June 9.

However, Fed chair Janet Yellen put those fears to rest by reiterating the prospect of low rates for some time to come at the June FOMC meeting. The impact of the Fed’s monetary policy would translate to low rates not only for U.S. Treasuries (TLT ), but also other forms of non-government debt (please refer to Part 2 of this series). This week’s flows in investment-grade debt may reflect this.

To read about how key trends at last week’s Treasury auctions, please read the Market Realist series, Must-know: Why investors favor long-term Treasuries again .