By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) -Bond investors are bracing for a U.S. economic downturn, as they pare back risky exposures, while many are extending duration in their fixed-income portfolios, taking in to account a Federal Reserve that is in no rush to resume cutting interest rates.
In the run-up to this week’s two-day Federal Open Market Committee meeting, investors have been extending duration. That entails buying longer-dated assets in anticipation of a further decline in yields and suggests that the bond market is positioning for a deeper-than-anticipated rate-cutting cycle. Investors have been lengthening duration for the last month at least, market participants said.
J.P. Morgan’s latest Treasury Client Survey showed bond investors having the largest net-long position on Treasuries since the autumn of 2010. The extreme overbought situation could be a contrarian indicator, however, suggesting a possible technical bounce for bond yields in the near term.
The bond market’s long positioning is likely due in part to fears of recession, analysts said, as the Trump administration continued to pummel the United States’ trading partners with aggressive import tariffs that set the stage for a global trade war.
“We have been heavier on duration and lighter on credit relative to our previous positioning and for a month or two, it was hard for people to imagine why we might be positioned like that,” said Christian Hoffmann, head of fixed income and portfolio manager at Thornburg Investment Management in Santa Fe, New Mexico.
“The economy today … still seems OK. But it’s really concerns about the future and people wondering how these policies — that change not just daily but intra-day — might impact prices and geopolitical trade.”
Futures traders in U.S. federal funds, which measure the cost of unsecured overnight loans between banks, expect the Fed to hold interest rates steady in the 4.25%-4.50% range at the end of its meeting on Wednesday.
They have also priced in about 62 basis points (bps) of easing in 2025, or about two rate reductions of 25 bps each, LSEG calculations showed. The next rate cut is expected to occur in June, unchanged from what traders priced in after the January policy meeting.
Fed Chair Jerome Powell, at his press briefing on Wednesday, will probably signal that the committee will remain patient in cutting rates as the economy does not seem to be falling off a cliff. The U.S. central bank can hold off indefinitely, analysts said, as it seeks more clarity about the Trump administration’s economic policies.
Investors will also focus on Fed policymakers’ quarterly economic projections. Included in that are interest rate forecasts and what is known as the “dot plot,” which reflects how much easing is expected. The December dot plot called for two rate cuts this year, which would leave the fed funds rate at 3.9%.
MORE JUICE LEFT FOR LONG DURATION?
Market players think the Fed will probably maintain its December guidance of two rate reductions this year. Since December, U.S. inflation, as measured by both consumer and producer prices, has surprised to the downside, although other indicators point to lingering price pressures. The labor market, on the other hand, remained resilient.
But bond investors’ reach for duration is partly driven by fears the economy may worsen further.
Barclays in a research note pointed out that consumer and manufacturing sentiment has worsened amid concerns about tariffs, and this uncertainty has grown significantly from what happened in 2018-19, when President Donald Trump first launched tariffs under his first administration.
Barclays has recommended taking a long position in five-year Treasuries.
“I think the concern is that we have a policy-induced recession, or we talk ourselves … in to some sort of recession just based on the fact that … corporate America and even the consumer doesn’t necessarily want to spend or take on additional risks until we get greater clarity,” said George Catrambone, head of fixed income in the Americas at DWS in New York.
DWS, however, has reduced duration in its bond portfolio to a more neutral stance, having captured the move lower in yields.
Brij Khurana, senior managing director, partner and portfolio manager at Wellington Management in Boston, thinks long-duration Treasuries are still attractive from a valuation perspective, believing bond yields have further room to decline. But at the same time, he is looking at opportunities elsewhere, in countries such as Australia and New Zealand, which have higher rates than the United States.
Fixed-income investors will also pay attention to comments by the Fed’s Powell on the future path for quantitative tightening, which refers to the U.S. central bank’s efforts to reduce its Treasury debt and mortgage bond holdings.
In the minutes of the January policy meeting, Fed officials contemplated slowing or pausing bond drawdowns amid uncertainty over how the U.S. Treasury will manage debt issuance over the next few months.
(Reporting by Gertrude Chavez-Dreyfuss in New York; Editing by Alden Bentley and Matthew Lewis)
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