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'Taper tantrum' Part II hitting the bond market

Santelli: Rate hike signals

With the Federal Reserve nearing its first rate increase in about 6½ years, bond investors are bracing for the shock.

Fixed income funds in recent weeks have seen their biggest cash outflows since 2013's "taper tantrum," which occurred after then-Fed chairman Ben Bernanke first signaled to the markets that the central bank's massive liquidity program was coming to an end.

Bond exchange-traded funds have coughed up $7.3 billion in March, a pace that if continued would exceed the exodus that began in May 2013, according to market data firm TrimTabs.

The market is bracing itself for the Fed's direction this year as the Open Markets Committee prepares for liftoff from a policy instituted during the dark days of the financial crisis. The FOMC dropped its target funds rate to near zero—0.11 percent as of Friday—and targeted gains in unemployment and inflation before it would raise. On its face, the funds rate dictates how much banks charge each other to borrow money, but at its core it determines lending rates throughout the economy.

On Wednesday, the FOMC is set to conclude its March meeting, with expectations that it will drop the word "patient" from the post-meeting policy statement. That in turn would signal to markets that a rate hike is coming, likely either in June or September.

However, the U.S. economy has slowed considerably, with many economists taking down growth projections for the first quarter from close to 3 percent to less than 2 percent. One indicator, from the Atlanta Fed, has Q1 growth at 0.6 percent.

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In an analysis accompanying the flows report, TrimTabs said the recent economic developments, which have seen anemic levels of retail sales, production, producer prices and construction, could point to a longer delay for a Fed rate hike.

"Most of the macroeconomic data we track points to a loss of economic momentum rather than an acceleration in growth; debt levels in the economy are very high, and the U.S. dollar has exploded higher as central banks around the world compete to outdo one another with stimulative policies," the report said.

Indeed, despite the bearish fund flows, the benchmark 10-year Treasury traded at 2.08 percent Monday afternoon—about where it started the month, and considerably off the most recent high of 2.24 percent on March 6.

Still, some investors aren't taking any chances amid the volatile gyrations in the market.

A look at flows for individual ETFs shows how much has fled from bond-based funds in March, with one corporate bond offering shedding more than $1.8 billion alone:

Biggest ETF outflows in March

FundTickerNet flows (in millions of dollars)Total for the year
SPDR S&P 500SPY-4,226.06-30,425.36
iShares iBoxx $ High Yield Corporate BondHYG-1,858.001,373.11
iShares MSCI Emerging MarketsEEM-1,757.07-2,714.95
iShares 20+ Year Treasury BondTLT-1,311.64-206.34
iShares 7-10 Year Treasury BondIEF-1,011.86-782.60
iShares Short Treasury BondSHV-793.871,532.69
iShares U.S. UtilitiesIDU-779.32-1,092.24
SPDR GoldGLD-777.471,691.15
Utilities Sector SPDRXLU-770.69-463.18
SPDR Barclays High Yield BondJNK-756.201,098.55

Five of the top 10 outflows for the month belong to bond-related funds, though several have net inflows for the year.

Whether that continues could hinge largely on the kind of language the Fed uses in its statement. While many market participants believe the word "patient" indeed will leave the statement, the bigger question is what replaces it.

"The Fed does not want a repeat of the 2013 taper tantrum, so we look for some calming offsets between the statement, the Summary of Economic Projections, and [Fed Chair Janet] Yellen's remarks to the press," Bank of America Merrill Lynch economist Michael S. Hanson and others said in a note Monday. "While recent Fed speeches suggest a strong dovish tilt is unlikely at this meeting, we still expect the Committee will end up postponing liftoff until September at the earliest."

Hanson said that in addition to the language change, the Fed also is likely to adjust its inflation expectation with a "slight downward drift."

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