U.S. federal spending: $100 a second for 2,248 years

Global equity funds experienced $4.1 billion in outflows for the week ending May 21, ending an eight-week inflow streak, as investors rotated into bonds ($25B inflow), money markets ($16.1B inflow), and crypto ($2.3B inflow); tech stocks saw a record $6.8B outflow, largely due to liquidation of the FNGA ETF. BofA strategists highlight concerns about unsustainable U.S. government spending and the potential negative impact of bond yields above 5% on risk assets, suggesting a shift away from bonds driven by persistent inflation and tighter monetary policy.

Analysis

Global equity funds experienced a significant shift in investor sentiment for the week ending May 21, with outflows of $4.1 billion snapping an eight-week streak of inflows, as reported by Bank of America. This capital rotation saw substantial allocations into bonds, which attracted $25 billion, and money markets, which added $16.1 billion, alongside $2.3 billion flowing into crypto assets. Conversely, gold registered its third-largest weekly outflow ever, losing $2.9 billion. The technology sector witnessed a record $6.8 billion exit, predominantly driven by the $6.7 billion liquidation of the leveraged FNGA ETF. Fixed-income markets showed broad strength, with investment-grade bonds leading inflows at $13.5 billion, their strongest weekly gain since September. High-yield bonds continued their positive momentum with a fourth consecutive weekly inflow of $1.9 billion, accumulating $9.8 billion over four weeks—the most since November. Emerging market debt also saw robust inflows of $1.7 billion, the best since January 2023, while U.S. Treasuries attracted $5.1 billion. Bank of America strategists, led by Michael Hartnett, expressed concerns over the sustainability of U.S. government spending, noting the $7.1 trillion spent in the past year. They argue that bond yields above 5% are detrimental to the highly financialized U.S. economy and that bond vigilantes are now incentivized to penalize fiscal indiscipline. Hartnett specifically warned that 30-year Treasury yields exceeding 5% combined with a U.S. dollar index (DXY) below 100 would be negative for risk assets. The report also highlights a structural market pivot, suggesting the 40-year bond bull market has reversed, driven by persistent inflation, tighter monetary policy, expansive fiscal spending, and protectionist industrial strategies, marking an end to the disinflationary era that previously supported fixed income. Regionally, U.S. equity funds saw $1.8 billion in outflows, emerging markets experienced their worst week in 14 with $5.5 billion in outflows, and Japan recorded a $4 billion exit, while European equity funds demonstrated resilience with $400 million in inflows. Sector-wise, Materials, Financials, and Technology led the outflows.

Key Decisions for Investors

• Investors should acknowledge the significant rotation out of equities and into bonds and cash, potentially signaling a more defensive market posture and warranting a review of equity-heavy allocations.
• Consider opportunities within fixed income, particularly investment-grade and high-yield bonds which are attracting strong inflows, but remain cognizant of BofA's warning regarding the unsustainability of U.S. fiscal policy and the potential for yields above 5% to negatively impact risk assets.
• Monitor 30-year Treasury yields and the DXY closely, as sustained levels above 5% for yields and below 100 for the DXY are identified as potential headwinds for risk assets, and reassess exposure to sectors like technology, which saw record outflows, and emerging markets, which experienced substantial withdrawals.