ETF Investors Are Buying Treasuries and Dumping Junk Bonds

(Bloomberg) -- Investors are pouring cash into exchange-traded funds that provide protection against the stock market turning sour as interest rates are set to rise again and trade tensions between the U.S. and China escalate.

It’s been a banner month for the iShares 20+ Year Treasury Bond ETF, or TLT, which has taken in close to $2 billion in September, putting it on track for its second most monthly inflows ever. That includes $450 million of outflows on Monday and Tuesday. The fund holds longer-dated Treasury bonds, which typically lose value as rates rise, indicating investors may be more concerned about trade risks than an impending yield surge.

“I’m not surprised to see stocks selling off and some money being put into bonds,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance. “It sounds like a classic risk-off trade to me, and I think the escalation in the trade war is the catalyst.”

ETF Investors Are Buying Treasuries and Dumping Junk Bonds

Bond trades aimed at limiting risk are becoming increasingly popular. Investors have yanked more than $2.4 billion from the iShares iBoxx High Yield Corporate Bond ETF, or HYG, in September, putting it on track for a record month of outflows.

There’s $45 billion wrapped up in ETFs that track high-yield bonds, according to research by Bloomberg Intelligence analysts Eric Balchunas and Athanasios Psarofagis. Typically, that money exits as rates rise. Since 2013, average fund flows for high-yield bond ETFs were 88 percent lower in months when 10-year Treasury yields moved higher.

“High-yield can be much more linked to the performance of the broader economy, and even equity markets, than the Treasury curve or investment-grade,” said Jason Thomas, chief economist at AssetMark, which manages $47.5 billion.

Rate Risk

The Fed is expected to raise its benchmark interest rate for the third time this year following its policy meeting Wednesday, with a 2 percent to 2.25 percent target range widely anticipated. The yield on 10-year Treasuries hit 3.1 percent Tuesday, its highest since May.

Pouring money into TLT as interest rates rise is “counterintuitive,” said Todd Rosenbluth, director of ETF research at CFRA Research.

“TLT incurs more interest rate risk than nearly all other fixed-income ETFs, and as such has lost money in September,” he said. “Yet, investors concerned about stock market volatility may find comfort in the liquid exposure to Treasuries.”

The trade war between China and the U.S. intensified on Monday after the Trump administration imposed tariffs on $200 billion in Chinese goods, with Beijing vowing it would slap $60 billion in U.S. products in retaliation. And the tiff shows no signs of abating.

In a speech before the United Nations General Assembly Tuesday, President Donald Trump accused China of engaging in “relentless product dumping” and intellectual property theft that “cannot be tolerated.” Meanwhile, China reduced tariffs on imports from trading partners, which could mean it’s digging in for a much longer trade fight, according to Zaccarelli.

That’s reason for caution, not a market rally, he said.

“I think the risks of a prolonged trade war are greater than ever,” Zaccarelli said.

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