Investors withdrew billions of dollars from corporate bond funds over the past week as surprisingly strong inflation data prompted an aggressive interest rate hike by the Federal Reserve, heightening fears of a global economic slowdown.
For the week to June 15, $6.6 billion was withdrawn from funds buying lower-quality U.S. high-yield bonds, making it the deadliest week for fund managers since the worst selloff in the coronavirus pandemic in March 2020 and taking a year-to-date outflows to nearly $35 billion, according to financial data provider EPFR.
Outflows for funds buying investment-grade U.S. bonds reached $2.1 billion, the largest one-week total since April 2021.
Surprisingly strong inflation data at the end of last week prompted fund managers to reassess previous assumptions that the rapid rise in prices had begun to subside. It has also raised expectations of aggressive monetary policy tightening from the Fed, which some investors fear will stifle US growth and send the economy into recession.
Fed Chairman Jay Powell reiterated the central bank’s commitment to fighting inflation at its meeting this week, while acknowledging that some of the drivers – like the surge in commodity prices resulting from the war in Europe – were beyond his control.
“The banks led us into the  financial crisis. I think central banks will lead us into this one,” said John McClain, portfolio manager at Brandywine Investment Management. “Central banks have no antidote for this market. Rising rates will slow the economy, but it won’t stop the war in Ukraine and it won’t ease supply chains.
When interest rates are higher, the prices of existing fixed-rate corporate bonds fall to compensate for the lower interest rates investors earn on those bonds relative to new debt. But there are growing fears that an impending economic slowdown will test the ability of companies to service their debts, sending prices – which move in the opposite direction of bond yields – even lower this week.
According to an index maintained by Ice Data Services.
The extra yield above Treasuries on lower-grade junk bonds – which indicates the level of risk of lending to a private company versus the US government – has already increased by 0.66 percentage points this week. to 5.17 percentage points, putting credit risk repricing on track for its biggest single-week move since March 2020.
About $100 billion in junk debt is now trading at a spread of more than 10 percentage points above Treasuries, a commonly used definition of distress and a sign of how risky it is to lend to these companies , according to a $1.45 billion index run by Ice Data Services.
Fed officials “have only one way to kill inflation and that is the very gruesome and bloody tool of crushing demand, crushing the housing sector, crushing investment [and] crushing exports,” said David Kelly, chief global strategist at JPMorgan Asset Management. “It’s the only way they can do it.”