Author by Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) - Bond investors took a neutral stance at the Fed’s two-day monetary policy meeting this week, reflecting on the continued caution of U.S. trade policy that could put the world’s largest economy into a recession.
Fixed-income investors say they either remain neutral with respect to the benchmark or reduce long-term exposure or rather stay at the shorter end of the yield curve.
"We have an uneasy balance between growing economic issues, as we see a little sourness in soft data, but also the potential for policy shocks that could impact inflation outlook and deficits," said Chip Hughey, Fixed Income Managing Director at Truist Advisory Services in Richmond, Virginia.
Neutrality means sticking to the duration benchmark of the portfolio. For example, if the benchmark duration is five years, a neutral position will indicate staying in fixed income assets over a five-year or nearby.
Duration is expressed over several years, providing an indication that the value of a bond will drop or rise as interest rates move. Generally, higher bond bonds increase more value than bonds with lower duration.
Investors have extended their duration for much of 2024, and they believe that as the Fed will embark on a deeper cycle of price cuts. Long-term bets usually involve buying longer date assets, which is the expectation of a drop in yields.
The Federal Open Market Committee, developed by the U.S. Central Bank, was widely expected to keep its benchmark overnight interest rate in the range of 4.25%-4.4.50%. The U.S. non-agricultural wage data in April last Friday exceeded expectations, which also gave the Federal Reserve some room to keep interest rates unchanged.
Since the Fed's last meeting in March, President Donald Trump's administration has triggered a huge trade shock, allowing tariffs to increase effectively, especially on Chinese goods.
This drove the U.S. Treasury sell-off, at some point the benchmark 10-year yield exceeded 70 basis points (bps), up nearly 4.6% over the period from April 3 to 11. The 10-year yield in the United States is currently 4.357%.
Fed Chairman Jerome Powell may indicate at a press conference on Wednesday that Trump's tariff shock could lead to higher inflation and higher unemployment, and the recession is not a far-fetched situation.
No preemptive move
"Given that inflation will rise, the scale of the tariff shock may have a lasting inflationary effect, it is unlikely that the Fed will take preemptive action," Morgan Stanley analyst Michael Gapen wrote in a research note.
Since calling himself "Liberation Day" on April 2, Trump has backed down some U.S. tariffs, partially stabilizing bond and stock markets. But the overall market anxiety about what will happen next has not yet disappeared, investors said.
"We tell investors to continue to be cautious and dangerous," said Gregory Peters, co-chief investment officer for PGIM's fixed income.
"The way I see the tail is that the distribution has only one side: I can't see the tail upward. From the perspective of the yield curve, at the front end, more because at least it's driven by Fed policy," he refers to his expectations fighting the Trump administration's tariff policy.
He added that the backend, especially the 30-year bond, is “driven by factors that I control and understand far beyond.”
However, the market does not expect the Fed's price to remain unchanged for longer. According to LSEG, the benchmark federal funds futures market price is nearly 80%, and the U.S. central bank will resume its lower tax rates at its policy meeting July 29-30.
All in all, the market is expected to relax by about 77 basis points this year.
JP Morgan's latest Treasury Client Survey shows that 64% of Bank of America's customers are neutral and 24% overall. Jay Barry, head of global interest rate strategy at JP Morgan, said the net position on the bonds fell from a peak of 32% on April 7.
"We are currently neutral and tend to be a little more comforting at the front of the curve that it will be fixed on the Fed cuts," said Anders Persson, chief investment officer and head of global fixed income at Nuveen in Charlotte, North Carolina.
“It is a recognition that given all policy uncertainty, unclear context, we are not so willing to make big bets.”
(Reported by Gertrude Chavez-Dreyfuss; Edited by Alden Bentley and Paul Simoo)