Huge Inflows Into Short-Dated Treasury ETFs Signal Risk Reprieve

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(Bloomberg) -- There are signs the bull market’s putative Achilles’ heel -- crisis-era short-term dollar funding costs -- might heal soon.

Thank heavy inflows into low-duration funds.

Investors seeking to pare interest-rate risk poured a hefty $1.1 billion into the iShares 1-3 Year Treasury Bond ETF last week, the most since October 2014 and the fourth-largest allocation into U.S.-listed products across asset classes.

Rising demand for short-term debt has been fueled by inflation concerns that contributed to the recent market sell-off, and prompted investors to avoid assets with elevated duration risk such as longer-term bonds. Any downward pressure on yields at the front end may also benefit stocks -- whose appeal increases as the return on safe assets shrinks -- while easing borrowing costs for companies.

Passive fixed-income products with short duration took in $1.8 billion in the week to May 11, some 1.4 percent of their total assets, according to data compiled by Bloomberg. Flows into government bond funds with limited rate risk are running at one of their hottest five-day paces relative to the past year, according to Deutsche Bank AG.

"If these flows are sustained, they should help richen the front end, steepen the curve, and drive down front-end spreads," Deutsche strategist Steven Zeng wrote in a recent note. "The cash could also be invested into money markets, putting downward pressure on commercial paper rates and three-month Libor."

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