Emerging markets and junk bonds suffered as investors thanked the Fed for the promise of higher US yields

Jasper Jolly
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Fed Chair Janet Yellen Holds News Conference On Interest Rate Decision
Federal Reserve chair Janet Yellen said "gradual increases" in interest rates could be appropriate (Source: Getty)

Investors pulled money out of emerging markets and high-yielding bond funds at the fastest rate this year, positioning instead for bigger returns from US assets as the Fed continued on the path to normal monetary policy.

High-yield bond funds, which target junk bonds from riskier but higher-rewarding companies, saw their biggest outflows since the end of 2014, according to data provider EPFR, as the prospect of rising interest rates promised long-awaited higher yields.

Funds investing in emerging market equities suffered outflows for the third week this year, as investors looked to tilt further towards the US economy.

Read more: The Fed has hiked interest rates, sending the dollar tumbling

US equity funds saw inflows of $12bn (£9.7bn) over the week to Wednesday, as non-farm payrolls data smashed expectations for the second month in a row to show a strong US jobs market.

The election of Donald Trump as US President has coincided with signs of a US economy starting to accelerate, and a consequent return to higher interest rates in the world’s largest economy.

Trump was elected on a platform promising a large fiscal stimulus and massive deregulation, which has seen US equity markets boom to consecutive record highs.

Meanwhile the US economy had started to show signs of strengthening towards the end of the Barack Obama Presidency, although growth slowed in the fourth quarter of 2016 to an annual rate of 1.9 per cent.

A stronger economy nearing full employment and a more healthy global outlook prompted the Federal Reserve to prepare markets for a rate hike.

Read more: Is the US economy ready for higher interest rates?

The Federal Reserve’s move to raise interest rates on Wednesday represented only the third upward move this decade. The target range for the federal funds rate is now 0.75 to one per cent, its highest since 2008.

Emerging markets have been braced for increases in US interest rates, as the tightening of monetary policy threatens to slow the supply of credit to emerging markets and make dollar-denominated debt unmanageable.

The Fed’s move was heavily telegraphed, with the odds of a hike implied by federal fund futures rising well above 90 per cent according to calculations by CME Group.

Higher US interest rates usually lead to a stronger dollar, as investors anticipate lower inflation. However, the “dovish hike” actually caused the dollar to plunge, as the Fed toned down its rhetoric and pointed to a “gradual” path for a rate hike.

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