By David Graichen
Head of Capital Markets
Discordant is the best way to describe the markets at the moment. Markets rose and fell every other day as leading central banks implemented opposing strategies. For example, the Bank of England (BOE) announced last month that it would postpone quantitative tightening (QT) and resume buying long-end gilts. On the other hand, the Fed remains firmly in its emphatic hawkish tone as Fed members continue to pierce two key issues: Investors should expect more rate hikes, and inflation is a higher priority than a soft-landing recession. With its actions, the BOE introduced, albeit temporarily, a two-way risk into the market.
So where are the investors?
Well, according to Street, there are some notable flow trends that have emerged in this high-yield environment. A flight to quality trades continues to play out and shorter duration funds have become a topical part of the yield curve. As of September 28, the top five shorter-duration funds had amassed nearly $5 billion in inflows over the previous five days. Speaking of the front-end yield curve, China and Japan are likely to become big sellers of USTs as they strengthen their own currencies if they aren’t already. Last month’s Treasury meltdown, which saw the 10-year nominal yield surge above 4% in the Asia session, is a decent indication that FX reserve managers are selling Treasuries aggressively. Perhaps Japan was more likely to sell because the Bank of Japan has more spare cash. But that’s just a snapshot of market color lately. Let’s take a step back and see what has happened over the last few months.
In recent months, asset and model portfolios have increased duration as the UST curve has flattened. The same group also sells inflation-linked ETFs focused on energy. Ultimately, this type of investor believes that interest rates have peaked and therefore sells TIPS for nominal yields. We believe that this trend will continue in the future.
As markets remain bubbly, the color above is just a snapshot of the flows that have come through. As the market landscape changes, so do investors’ beliefs and their capital flows.
Originally published by WisdomTree on October 13, 2022.
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