Bond Traders Lean Into ‘Sweet Spot’ Amid Doubts About Fed’s Path
Jerome Powell during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington, DC, on Sept. 17.
(Bloomberg) — At BlackRock Inc., PGIM and other Wall Street firms, bond-fund managers are sticking to trades that will likely pay off even if the Federal Reserve’s path is again knocked off course by surprising turns in the economy.
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The run-up to the Fed’s first interest rate cut in nine months has already supplied solid returns, driving the Treasury market to its biggest annual gains since the pandemic forced the central bank to drive its lending rate to the cusp of zero.
But when Jerome Powell finally delivered the highly anticipated move on Wednesday, he underscored the need to balance cracks in the job market against the risks of rising inflation.
That’s strengthened conviction in what has proved a winning strategy for riding out that sort of uncertainty: buying the middle-maturity Treasuries that throw off interest payments and are more insulated from price swings caused by rapid-fire reversals to the economic outlook.
“The longer term path is for a weaker economy and most likely lower rates to go along with that,” said Christian Hoffmann, portfolio manager at Thornburg Investment Management. But, he said, there’s a lot of uncertainty because it’s “increasingly difficult to draw a straight line from the evolution of the data to the Fed’s reaction.”
The case for the Fed’s shift back to cutting rates has been supported by a steep slowdown in the pace of hiring over the past several months as businesses braced for the impacts of President Donald Trump’s trade war.
But at the same time, other elements of the economy have held up and the president’s tariff hikes threaten to rekindle inflation that’s already stubbornly above the Fed’s 2% target.
At his press conference on Wednesday, Powell characterized the Fed’s quarter-point move as “a risk management cut” and said policymakers would be taking things “meeting by meeting,” even as their forecasts indicated two more reductions are likely this year. The comments dragged on the bond market, pushing yields up across maturities through the end of the week, by dashing some speculation that it was poised to usher in a more aggressive series of cuts.
Russell Brownback, the deputy chief investment officer of global fixed income at BlackRock, said dynamics favor a focus on the so-called belly of the yield curve, or those maturing around the 5-year range. That’s been one of the strongest performing segments this year, with a Bloomberg index of 5- to 7-year Treasuries returning roughly 7%, beating the broader market’s 5.4% gain.
“The belly is the sweet spot,” he said.
Greg Peters, co-chief investment officer at PGIM Fixed Income, echoed that sentiment. He said the fixed interest payments on those securities are high enough to make a profit by using borrowed money to purchase them, what’s known as positive carry. They also provide capital appreciation as the securities get closer to maturity.
“Positive carry and roll: it’s the bond investor’s dream,” he said.
The approach provides somewhat of a buffer from the risk that a jump in inflation or stronger-than-expected economic data will cause the Fed to change tack. Already, the Fed’s updated rate forecasts showed a wide dispersion of views.
Overall, it indicated they largely expected to cut rates over the next two meetings, with single quarter-point reductions penciled during 2026 and 2027, a less aggressive path than what has been priced into the futures market.
That backdrop sparked some to unwind their pre-cut rally trades, with the strategy team at Natixis SA closing a long recommendation on two-year Treasury notes on Thursday.
Andrew Szczurowski, a portfolio manager at Morgan Stanley Investment Management, said the market’s current pricing may well be more accurate than the Fed’s forecasts. He said he anticipates that the Fed will err on the side of protecting the labor market by continuing to dial down borrowing costs, providing some room for the bond market to extend its gains.
Szczurowski, whose $12 billion Eaton Vance Strategic Income Fund returned 9.5% this year, beating 98% of its peers, said he’s been telling clients that “you missed some of the rally, but there’s still upside.”
“It’s a bond picker’s market,” he said.
What to Watch
Economic data:
Sept. 22: Chicago Fed national activity index
Sept. 23: Philadelphia Fed non-manufacturing activity; current account balance; S&P Global US manufacturing, services and composite PMIs; Richmond Fed manufacturing index and business conditions
Sept. 24: MBA mortgage applications; new home sales; building permits
Sept. 25: Initial jobless claims; Advance goods trade balance, imports and exports; wholesale and retail inventories; GDP Annualized QoQ (Q2T); GDP price index; personal consumption; durable goods orders; capital goods orders; existing home sales; Kansas City Fed manufacturing activity
Fed calendar:
Sept. 22: New York Fed President John Williams; St. Louis Fed President Alberto Musalem; Cleveland Fed President Beth Hammack; Richmond Fed President Tom Barkin; Fed Governor Stephen Miran;
Sept. 23: Fed Vice Chair for Supervision Michelle Bowman; Atlanta Fed President Raphael Bostic; Chair Jerome Powell
Sept. 24: San Francisco Fed President Mary C. Daly
Sept. 25: Chicago Fed President Austan Goolsbee; Williams; Fed Governor Michael Barr; Dallas Fed President Lorie Logan; Daly; Bowman
