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Bond euphoria swells but don’t discount autumn shock – BAML

While bonds have become the new stocks for many investors, ‘Taper Tantrum II’ remains a real threat for asset markets this autumn, warned Bank of America Merrill Lynch ahead of Fed chair Janet Yellen’s Jackson Hole speech today.


Kristen McGachey

Bonds in particular have seen “euphoric flows,” the bank said, with investors convinced that interest rates in developed markets will stay at record low levels in the short-term. BAML’s data revealed bonds had taken in $6.6bn (€5.8bn) after seeing inflows in 19 out of the past 21 weeks. 

Investment grade, high yield and municipal bonds continued their trend of consecutive weekly inflows, according to the report. Investment grade bond funds proved especially popular, hitting $3.9bn in inflows.

Government bonds was the only fixed income category to report outflows, losing $0.4bn over seven weeks.

However, investors should resist getting caught up in the current bond euphoria the bank argued, especially given Yellen’s impending speech.

Though Jackson Hole has only been a big market driver once in the past decade, the bank cautioned that the 2016 symposium has “volatility-potential” due to investor positioning in assets that rely on “zero rate” expectations and hints that have been dropped by the Fed thus far.    

“The Fed is capitulating on their forecasts of higher inflation & interest rates,” said BAML. “Market expectations of “bond-friendly, risk-on, dollar-off” dovish JH Fed have thus begun.”

Meanwhile, investors were not feeling the love for equities and continued to aggressively pull out of the asset class as a December rate hike by the Fed is seen as increasingly likely. The asset class saw $4.2bn in outflows, its first outflows in three weeks, said BAML.

European equities’ longest outflow streak on record continued as the category lost $2.0bn for the 29th straight week.  US equities did not fare well either, losing $4.4bn, its largest outflow figure in 8 weeks.

The prospect of a stronger dollar also slightly deterred investors from emerging markets on the debt and equity side. EM debt only managed to rake in $0.9bn last week, which were the weakest inflows the class has seen in eight weeks.

EM equities also registered another week of marginal inflows, totalling just $30m. While BAML has not raised the sell-signal quite yet, it said another $8bn outflows over the next two weeks would be enough to do so.