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Nov 1, 2017

S3 Analytics: Corporate Bond ETF Activity Prior to Fed Hikes

Inflows into corporate bond ETFs have been active this year, with $11.7 billion of buying in the three corporate bond ETFs which have over $10 billion of AUM and $100 million of short interest. Buyers increased their long position in the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and Spider Bloomberg Barclays High Yield Bond ETF (JNK) by 19% in 2017 bringing their aggregate AUM to $71.7 billion.

In 2017, short sellers in these three corporate bond ETFs were also active, increasing their short exposure by $2.4 billion, or 44%, bringing total short interest to $7.7 billion.

Over the last month especially, both longs and shorts have been increasing their exposure in these three corporate bond ETFs. With longs buying $1.8 billion of the ETFs and shorts selling $1.2 billion.
Long and short activity in these corporate bond ETFs can be attributed to several factors, including:
• President Trump’s impending decision on a new Fed Chair which will define future dovish or hawkish fiscal activity.
• The possibility of the administration passing tax reform in 2017 which will be bullish for the economy and interest rates.
• An uptick in post-hurricane job growth, which will be a positive influence on wage growth.
• The price of crude inching towards the $55/barrel level which may give a boost to the oil sector
• Credit spreads over Treasuries hitting lows throughout the corporate credit curve which is forcing corporate rates even lower.
• Investors continually looking for yield which is pushing activity further down the credit curve.

Activity in corporate bond ETFs has been historically active prior to Fed rate moves, with long buyers and short sellers acting in concert prior to the Fed Funds rate increase.
There was no consensus prior to the Fed’s 25 bp rate hike on March 15th , with the probability of a Fed hike 50% or less (as per CME Futures activity) in the month and a half prior to the Fed decision. In response, long ETF holders sold off $919 million of their exposure while short sellers added $2.5 billion to theirs.

Traders were more certain of the June 15th Fed rate hike, with a two out of three chance of a rate hike at the beginning of May increasing to a near certainty a week prior to the move. Long ETF holders increased their position by $7.6 billion while shorts covered $2.1 billion of theirs.

A Fed Funds rate increase at the December 13th Fed meeting looks like a certainty at the moment, with a four out of five chance that the Fed Funds rate is increased to 1.50%. If this probability continues to hold true, and past long and short ETF activity repeats itself, we should see continued long side buying and an increase in short covering. The corporate bond ETFs should be seeing a price tailwind over the next few months.

Want deeper insight into the above analysis? Contact:
Managing Director Predictive Analytics, S3 Partners, LLC
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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