Bond Bears Get Smoked as $3.3 Billion Is Poured Into Credit ETF

(Bloomberg) -- The unexpected rebound across bond markets looks especially painful for one cohort of traders who had stacked up record bets against a $36 billion credit fund.

The iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker LQD) surged by the most in a year on Monday. It was up again on Tuesday morning in New York, headed for the biggest four-day rally since May 2020. That's likely lashing bears who boosted short interest in the fund to an all-time high last month, according to data from IHS Markit Ltd.

High-grade credit has been hammered this year as investors prepare for aggressive tightening by the Federal Reserve to control inflation. But Russia's invasion of Ukraine has traders now dialing back rate-hike bets.

At the same time, a two-month selloff may be enticing dip-buyers. LQD's comeback has been powered by a flood of cash -- the ETF has absorbed $3.3 billion across seven straight days of inflows, Bloomberg data show.

“Spreads have widened to a point where investment-grade credit once again offers at least something resembling relative value,” said Dan Krieter, a strategist at BMO Capital Markets. “While corporate fundamentals should remain strong despite the geopolitical risk, the conflict may induce central banks to take their foot off of the tightening pedal, at least a little bit.”

Now short interest as a percentage of LQD shares outstanding and put open interest in the fund are both easing from all-time highs. The rebound has helped trim the ETF's decline this year to less than 6%. It was up 0.3% as of 10:21 a.m. in New York on Tuesday.

Also helping the fund: The recent volatility in bond markets has kept borrowers sidelined. That lighter-than-normal supply has been a temporary tailwind for high-grade debt, reckons Krieter.

“As issuance dried up, the pace of spread widening slowed,” he said. “But the jury is still out on this one -- we need to see the primary market machine start back up again in force and for spreads to hold and moderate new-issue concessions before I'll be convinced that investment-grade is on firm footing once again.”