Bonds that have seen the most traffic lately

It is September. The leaves are turning, kids are back in school, and it is time for the next meeting of the U.S. Federal Reserve Board of Governors (Fed). The September meeting is usually one of the more important sessions of the year. It comes after the close of the summer, when trading and market activity typically starts to pick back up. It is also the first meeting after the Fed’s annual summit in Jackson Hole . Investors look to the September meeting for new insights or guidance about the Fed’s next steps.

As of September 15 the Fed funds futures market is pricing in only an 18% chance (source: Bloomberg data) that the Fed will raise its target interest rate from the current level of 0.25% to 0.50%. The odds of a rate hike have been declining in recent weeks as a combination of tepid data and comments by Fed governors have led most investors to believe that there won’t be a move. However, the Fed does seem to be getting closer to a hike, and it is likely to drop some clues in the statement and press conference that follow the meeting. Best guess, we’ll likely get a hike at the December meeting.

Given this backdrop, what have investors been doing with their money? The chart below shows the capital flows for U.S. fixed income exchange-traded funds (ETFs) from the last Fed meeting to September 14.

The first thing that jumps out at me from this Bloomberg data is the continued search for yield. Investors have put money into investment grade corporate bonds and emerging markets —two sectors that have historically provided above average levels of income compared to other fixed income segments. This isn’t really a surprise given how low yields are in the market. It is increasingly difficult to generate income in a bond portfolio, driving many investors to seek out new sources of income. Investment grade corporate bonds and emerging market debt have benefited from this trend for most of 2016. Flows into broad market funds are strong as well, which shows how investors are using fixed income at the core of their bond portfolio. Broad market funds tend to provide diversification against equity risk, potentially providing ballast to a portfolio.

Another interesting trend has been the interest in high yield bonds . Flows have been positive, but not as strong as other bond sectors. I think many investors may still feel tentative about the high yield market in the wake of the volatility in energy-related bonds earlier this year.

Flows into U.S. Treasury bonds have been more mixed. Nominal Treasury securities have had small net outflows, a big change from the large outflows they experienced leading up to the June Fed meeting. Meanwhile, Treasury Inflation-Protected Securities (TIPS) had some inflows as investors position for potentially higher inflation down the road.

Where does this leave us?

From the fixed income flow data, investors don’t seem to fear a Fed rate hike or expect a fast trajectory for rising rates. They have shown interest in funds that potentially provide some income or protection from inflation, and investment grade credit, emerging market debt and TIPS benefited from that. More and more yield-searching investors are considering nontraditional income asset classes, but keep in mind that higher income could mean higher volatility, with the most recent example being high yield debt. If you take on more risk, make sure you thoughtfully diversify your income sources, particularly as we near the next Fed rate increase.

Matt Tucker , CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog .