What Caused the Rout in High-Yield Bond ETFs?

Junk bond ETFs have had a muted run lately with popular funds SPDR Barclays High Yield Bond ETF (JNK) and iShares iBoxx $ High Yield Corporate Bond ETF (HYG) shedding about $1.28 billion and $1.27 billion in assets since the start of October (as of Oct 16, 2018). The funds have lost about 0.14% and 0.02% in the past week (as of Oct 12, 2018).

According to TrimTabs Investment Research, high-yield bond exchange-traded funds saw $4.1 billion of funds gushing out in the five trading sessions through Thursday. The outflows marked around 10% of the overall junk bond ETF market, per an article published on MarketWatch. That outflows represented the largest week-long outflow for high-yield ETFs since TrimTabs has been tracking the data.

Let’s look at the reasons for this massacre.

Rising Bond Yields

The year 2018 has not been favorable for the fixed income market so far, thanks to the steep rise in yields. As of Oct 15, 2018, the yield on the benchmark 10-year Treasury note was 3.16%, up from 2.46% at the beginning of the year. The yield reached as high as 3.23% on Oct 5. The primary reasons for the continued increase in treasury yield are the Fed’s hawkish stance in the monetary policy. This tendency has kept U.S. Treasury yields on an upward trajectory.

Investors should note that the Fed has enacted eight rate hikes since December 2015. Many Fed officials also gave hawkish comments recently. Junk bond ETFs, known for higher yields, are likely to underperform in a rising rate environment (read: Yields Are Soaring: Here's How to Short Treasury With ETFs).

Slump in Equities

Junk bonds tend to act more or less like stocks in their market behavior. With rising rate worries weighing on the broader equity market, junk bonds were not spared as well. Meanwhile, strength in the U.S. economy has encouraged the Fed to adopt a hawkish stance. If the Fed enacts faster-than-expected rate hikes in the coming days, rates will eventually scale higher. The gradual end of cheap money era led to a huge selloff in the equity market.

The S&P 500-based SPY has lost 5.2% in the past five days (as of Oct 15, 2018), Dow Jones Industrial Average-based (DIA) slid about 3.3%, Nasdaq-100 ETF Invesco QQQ Trust QQQ plunged about 5%, iShares MSCI Emerging Markets ETF EEM slipped about 4%, Vanguard FTSE Europe ETF VGK fell 6% and all-world ETF iShares MSCI ACWI ACWI retreated about 4.6% (read: 5 Defensive ETFs to Survive Global Market Rout).

Oil Price Volatility

Both OPEC and the International Energy Agency expect global oil consumption to rise by about 1.36 million barrels a day next year. The outlook is way gloomier than either group had projected back in July. “High prices, trade wars and weakening currencies are taking their toll on demand growth,” per business standard. Though analysts believe that a decline in demand will not leave a material impact on oil prices, volatility is likely to remain in the oil patch. This may cause upheaval in the junk bond space. Fears of default by the energy companies amid oil price pressure normally prompt junk bond sell-offs.

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