U.S. markets closed

Are the Bears Leaving the Bond Market Picnic?

This article was originally published on ETFTrends.com.

Fixed-income bears could be leaving the bond market picnic, according to a Reuters report that said hedge funds have recently backed off their bearish beats as U.S. equities continue to march forward on shaky legs while Federal Reserve officials speak with dovish tones.

"Speculators on U.S. futures markets slashed their bearish bets on 5-year Treasuries last week by the fifth largest amount since the Commodity Futures Trading Commission began compiling data in 1995," wrote Jamie McGeever of Reuters. "This follows the third largest ever reversal in short 10-year Treasury futures the week before, and underscores the view that the Fed won’t raise rates next year nearly as much as it has indicated."

Fed Vice Chair Cautious

The latest hedge fund moves come even though the general consensus in the capital markets is that a rate hike is slated for December, but the decision will also hinge on data, judgement and a little extra, according to Federal Reserve Vice Chairman Richard Clarida.

"A monetary policy strategy must find a way to combine incoming data and a model of the economy with a healthy dose of judgment — and humility! — to formulate, and then communicate, a path for the policy rate most consistent with our policy objectives," said Clarida, as he delivered a speech to New York bankers.

Not long ago, it seemed that a fourth and final rate hike to cap off 2018 was a sure thing, but the sell-offs in October and its spillover into November may have caused the Federal Reserve to take on a more dovish tone heading into December. Currently, the CME Group's FedWatch Tool, an algorithm that calculates the probability of a rate hike in a given month, is showing a 79.2% chance the Federal Reserve will institute a fourth rate hike for December.

However, comments from various Fed members might be signaling otherwise.

Doves In, Bears Out

While the bears may be exiting the bond markets, the economic doves may start to be appearing as 2018 comes to a close. Fed Chair Jerome Powell exhibited signs of cautiousness as he discussed the economy at a symposium with Dallas Fed President Robert S. Kaplan earlier this month.

"So, you know, a good example is — a noneconomic example would be you’re walking through a room full of furniture and the lights go off. What do you do? You slow down. You stop, probably, and feel your way,” Powell said.

In the meantime, Federal Reserve Bank of New York President John Williams is keen to sticking with hiking rates--somewhat.

“We’ll be likely raising interest rates somewhat but it’s really in the context of a very strong economy,” Williams said at a community event in New York on Monday. “We’re not on a preset course. We’ll adjust how we do monetary policy to do our best to keep this economy going strong with low inflation.”

In an interview with the Wall Street Journal this month, Federal Reserve Bank of Philadelphia President Patrick Harker was outright convinced that a December rate hike is not the most optimal move given the latest rumblings in the markets.

“At this point, I’m not convinced a December rate move is the right move, but I need to watch the data over the next few weeks before determining whether it is prudent to boost the cost of borrowing again.”

Despite the latest comments from his colleagues and recent volatility roiling the capital markets, Clarida maintains that the economy is still robust.

"U.S. economic fundamentals are robust, as indicated by strong growth in gross domestic product and a job market that has been surprising on the upside for nearly two years," Clarida said.

Short-Term Bond ETF Exposure

As institutional investors pare their bearish bets on bonds, retail investors are still focusing on short-term debt through investment vehicles like fixed-income exchange-traded funds (ETFs). An example would be the SPDR Portfolio Short Term Corp Bd ETF (SPSB), which seeks to provide investment results that correspond to the performance of the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index.

Another short-term bond ETF option is the iShares 1-3 Year Credit Bond ETF (CSJ), which tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years–this shorter duration is beneficial during recessionary environments.

For more trends in fixed income, visit the Fixed Income Channel.