Bond Funds Are on a Record Pace After Raking in Nearly $400 Billion in the First Half of 2024

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Investors have flocked to bond funds this year, driven by the commencement of interest-rate cuts from central banks worldwide.

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According to EPFR data, bond funds have already seen nearly $400 billion in net inflows, accounting for approximately 51% of the full-year record set in 2021. Cameron Brandt, director of research at EPFR, noted in a Monday client note that "actively managed funds have absorbed the biggest share of the flows so far this year."

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In 2022, actively managed fixed-income funds suffered significant losses as the Federal Reserve and other central banks globally began raising rates to combat inflation. These rate hikes severely impacted low-coupon bonds issued in the low-rate environment of the past decade, particularly as new securities began offering some of the highest yields seen in 15 years.

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The Bloomberg U.S. Treasury 20+ Year bond index has struggled, showing a 1.1% return month-to-date but facing a three-year return of minus 30.4%, according to FactSet data. Similarly, the iShares 20+ Year Treasury Bond ETF (TLT) is on track for a three-year return exceeding minus 30%.

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However, a shift towards rate cuts has already started. In June, the European Central Bank reduced rates by 25 basis points to 3.75%, down from a record high of 4%. While the Federal Reserve typically leads global rate cuts, its policy rate has remained in the 5.25% to 5.5% range, a near two-decade high. Yet, with the U.S. unemployment rate rising to 4.1% in June and other indicators suggesting potential economic weakening, more investors anticipate that the Fed will soon lower rates.

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As U.S. stocks (SPX, DJIA, COMP) reached fresh record highs at midyear, the 10-year Treasury yield (BX

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) retreated from a pandemic high of 5% to about 4.27% as of Monday, according to FactSet. This compares to 3-month Treasury bills (BX

) trading at a yield of 5.35%.

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The substantial inflows into bond funds this year are a stark contrast to last year's outflows. In 2022, many investors pulled out of actively managed fixed-income funds due to the rapid rate hikes by central banks. These hikes aimed to curb inflation but negatively impacted low-coupon bonds issued during the past decade’s low-rate environment. New securities offering higher yields compounded the issue, making older bonds less attractive.

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Despite these challenges, the bond market's outlook has started to shift positively with the initiation of rate cuts. The European Central Bank's recent rate reduction is a significant indicator of this trend. Although the Federal Reserve has yet to cut rates, maintaining its policy rate in the 5.25% to 5.5% range, signs of economic slowdown in the U.S. have led many to believe that rate cuts are imminent. The rising U.S. unemployment rate and other economic indicators suggest that the Fed may soon pivot to a more accommodative stance.

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The performance of U.S. stocks has been strong, with indices like the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite reaching new highs by midyear. At the same time, the 10-year Treasury yield has decreased from its pandemic peak, signaling a shift in investor sentiment. The yield on the 10-year Treasury has dropped to about 4.27%, down from a high of 5%, while 3-month Treasury bills are yielding 5.35%.

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In summary, the significant inflows into bond funds reflect a growing investor confidence as central banks begin to lower interest rates. Despite the heavy losses faced by actively managed fixed-income funds in 2022, the landscape is changing.

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The initiation of rate cuts by the European Central Bank and the potential for similar moves by the Federal Reserve have contributed to a more optimistic outlook for the bond market. Investors are now positioning themselves to take advantage of these favorable conditions, with the expectation that bond yields will continue to improve as rates decline. This shift marks a significant turnaround from the challenges faced last year and highlights the dynamic nature of the global financial markets.

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