By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) – U.S. bond investors are gearing up for increased volatility and staying defensive in their portfolios amid uncertainty about the impact of the Trump administration’s policies and signs that the Federal Reserve’s interest rate cuts may be on a lengthy pause.
Portfolio managers continued to shy away from the long end of the U.S. Treasuries curve – from 10-year notes to 30-year bonds – ahead of a Fed policy decision this week. Many investors have also remained neutral relative to their benchmarks because of the cloudier interest rate path in 2025.
The U.S. central bank’s policy-setting Federal Open Market Committee is widely anticipated to keep its benchmark overnight interest rate in the 4.25%-4.50% range at the end of its two-day policy meeting on Wednesday. Fed Chair Jerome Powell will likely strike a cautious tone in his post-meeting press conference and keep the central bank’s options open to allow policymakers time to assess how President Donald Trump’s administration will reshape the fiscal landscape.
There is little urgency for the Fed to ease policy given the relative strength of the U.S. economy and the labor market. There is a risk that inflation, while showing signs of slowing, could reaccelerate due to broad tariffs that could be slapped on a slew of imported products along with deportations of undocumented aliens that could cause a spike in wage pressures.
“I would think that adding duration into the unknown is probably a bad idea, especially as we have no clue what’s going to happen over the next year,” said Byron Anderson, head of fixed income at Laffer Tengler Investments in Scottsdale, Arizona.
Investors were quick to extend duration, or buy longer-dated assets, last year when they thought the Fed had embarked on a deeper rate-cutting cycle. Longer-dated notes and bonds have historically outperformed shorter-duration assets like cash and Treasury bills in easing periods.
But in the last quarter of 2024, there was a retreat from long-duration positioning, analysts said.
This month, however, as the 10-year yield hit a 14-month high of 4.809%, active investors have added duration, according to the latest JP Morgan’s Treasury Client Survey, which showed the most net long positions since Dec. 2.
MORE NEUTRAL
The survey also showed that the number of bond investors with neutral positioning relative to their benchmark has also increased by three percentage points since the first week of January. Overall, the survey showed more neutral positioning than long.
“We are pretty close to neutral duration. A lot of our overweights are in that three- to five-year part of the curve, less in 10s,” said Mike Sanders, portfolio manager and head of fixed income at Madison Investments in Madison, Wisconsin.
“I don’t see the Fed being able to aggressively cut more than twice this year … unless there is a pretty bad slowdown, which we don’t think is the case right now.”
A selloff in technology stocks on Monday rattled the bond market, leading to a multi-week decline in Treasury yields and caused the U.S. rate futures market to price in two rate cuts of 25 basis points (bps) this year. The market had factored in just one rate reduction all month until Monday.
The Fed’s own rate forecast, which was released in December, called for two quarter-percentage-point cuts next year, with the benchmark lending rate ending 2025 in the 3.75%-4.00% range.
A burgeoning U.S. fiscal deficit has further dampened the appetite for the long end of the yield curve. The U.S. deficit has doubled, from 3.1% of gross domestic product in 2016, just before Trump first took office, to more than 6% of GDP in 2024.
“We have much less conviction and are underweight on the long end of the curve because that is where the risk on fiscal policy is, especially with the amount of issuance,” said Brian Ellis, portfolio manager on the Broad Markets Fixed Income team at Morgan Stanley Investment Management in Boston. “And this issuance has to be taken by price-sensitive buyers.”
Laffer Tengler’s Anderson estimated about $14.6 trillion in Treasuries, in both short and long maturities, will come into the market in the next two years. Yet, the biggest bond buyer in the market – the Fed – is not there to absorb the bulk. That could push Treasury yields even higher, analysts said.
“The market has been more focused on fiscal policy. It’s front and center, and the reaction to monetary policy is a residual piece of the puzzle,” said Guneet Dhingra, head of U.S. rates strategy at BNP Paribas in New York.
“It’s a good time to be neutral in the Treasury market right now because the uncertainty level is extremely high. I don’t think there is much to fall back on to have conviction.”
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley and Paul Simao)
