Investors are pulling money out of bonds and money market funds at the fastest pace in years, as the specter of inflation and rising interest rates threaten short-term returns.
The outflow has been hardest for money market funds, which are cash-like funds with low levels of risk.
According to Morningstar Direct data, investors transferred $148 billion from money market mutual funds and exchange-traded funds between January 1 and February 16.
What’s more, they pulled out $134 billion in January, according to Morningstar, the category’s highest monthly exodus recorded in more than a decade.
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According to Morningstar, January saw monthly outflows from taxable and municipal bond funds for the first time since March 2020, during the US recession.
Before the pandemic, investors did not withdraw money from these bond funds during any of the months prior to 2018.
According to Morningstar, investors have withdrawn $9.8 billion from taxable bond funds and $3.4 billion from municipal bond funds from January 1 to February 16.
Inflation and high interest rates
It appears that investors are reacting to the potential impact of inflation and higher interest rates.
Money market funds are conservative, and typically invest in cash, short-term US government bonds and other safe securities. The high level of inflation is eating into the relatively low returns offered by such funds. The Consumer Price Index rose 7.5% in January from a year earlier, the fastest rate since February 1982.
The exit from money market funds in January was also the largest on record to start a calendar year, according to 1992 Refinitiv Lipper data. Outflows this month are on pace to set a new record for February.
The Federal Reserve is hoping to raise interest rates from March to cool the economy and tame inflation. However, bond prices move in the opposite direction to interest rates – meaning investors in bond funds will lose money as the central bank raises rates.
“The impending monetary policy tightening could push some investors to exit,” Morningstar research analysts Adam Sabban and Ryan Jackson said in a recent research note regarding bond outflows.
(Investors can expect bond returns to increase over time as the Fed raises its benchmark interest rate, as shorter-dated bonds will mature and fund managers can buy new ones at a higher yield.)
Investors also appear hesitant when it comes to US stock funds. He pulled out a net $20 billion from US equity funds in January, after adding an average of $12.5 billion a month in 2021, according to Morningstar. In contrast, investors poured $26.6 billion into international stock funds in January.
