The federal shutdown's impact on high yield bonds

Part 3

Extended government shutdown increases high yield bond appetite

A boost ahead?

An extended government shutdown mostly has bad consequences, but it’s boosting the high yield bond market (HYG).

In recent months, the high yield bond market had seen significant outflows driven by the expectations of tapering in September. The Fed decided not to taper last September, and this gave some extra life to the bond market.

Going into week 2 of the government shutdown, one thing’s for sure: any tapering is for sure postponed until at least December. This means the Fed will continue to boost the long end of the Treasuries curve, effectively providing price support for all fixed income classes.

US High Yield Bond Fund Flows 2013-10-07Enlarge Graph

High yield inflows strong

Last week, mutual funds focused on high yield flows saw an inflow of $238 million. While this amount is small compared to the $700+ million leveraged loans saw, it shows a reversal from the neutral fund flows the earlier week—a mere $3 million inflow.

Retail investors started pouring money into high yield funds (HYG) again since tapering was delayed in September. The extension of bond purchases caused a boost in intermediate rates (think five to ten years), which are the sweet spot for high yield issuance. The drop, of course, means bond prices increased.

Limited downside

The downside for now is limited given that even if sentiment reverses, high yield fund flows now have much higher cash balances, which they can use to cover any redemptions.

So over the next month or two, high yield funds (JNK) seem to be a safe place to park cash.

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