US Equity ETFs Shed $4.5 Billion as Investors Brace for Fed Rate Hike

Investors pulled nearly $4.5 billion from U.S. equity exchange-traded funds last week, a sharp reversal from the prior week's inflows, as persistent inflation data solidified expectations for an imminent Federal Reserve interest rate hike.

The weekly withdrawal compares to a $1.35 billion inflow during the previous week, according to a Saturday report from Jefferies. The shift in sentiment followed producer and consumer inflation reports that showed elevated price pressures, leading to a broad-based market decline.

Outflows Driven by Rate Expectations

The recent inflation data significantly altered market expectations for the Federal Open Market Committee's (FOMC) upcoming meeting. The probability of the central bank raising its key policy rate by 25 basis points surged to approximately 87%, up from about 59% just a week earlier.

This repricing triggered a sell-off in government bonds and stocks. The benchmark S&P 500 snapped a two-week winning streak, falling nearly 1%. Concurrently, the 10-year U.S. Treasury yield climbed 19.1 basis points for the week, ending at 4.975% and approaching the key 5% level.

Pressure on Rate-Sensitive Funds

ETFs sensitive to interest rates were the primary drivers of the outflows. According to Jefferies, the three largest funds tracking the S&P 500 saw combined net outflows of $3.23 billion, largely driven by a single significant withdrawal of $31.11 billion from the iShares Core S&P 500 ETF (IVV).

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Other key fund movements included:

• The Invesco QQQ Trust (QQQ), which tracks the tech-heavy Nasdaq 100, experienced outflows of $588.6 million, reversing a $2.62 billion inflow from the previous week.
• Consumer discretionary ETFs saw investors pull $528.3 million. Higher interest rates can reduce the value of future profits for technology firms and dampen spending in consumer-facing sectors.

Broader Fixed-Income Weakness

The risk-off sentiment extended to the credit markets. High-yield fixed-income ETFs registered more than $900 million in outflows for the second consecutive week amid the bond rout. Analysts at Jefferies noted that continued outflows from this category could slow debt issuance and cause credit spreads to widen.

Despite the headline weakness, the report highlighted that capital rotation was also at play. Jefferies observed that an equal number of ETFs saw inflows as outflows, with funds focused on Total Market, Financials, Low Volatility, and Health Care attracting new capital.