At BlackRock, PGIM (Prudential Investment Management), and other Wall Street institutions, bond fund managers are maintaining trading strategies that could continue generating profits even if the Federal Reserve's policy path deviates again due to economic surprises.
The preparation phase before the Fed's first rate cut in nine months drove the US Treasury market to its largest annual gains since the pandemic forced the central bank to lower lending rates to near zero, delivering substantial returns to market participants. However, when Fed Chair Jerome Powell finally announced the highly anticipated rate cut last Wednesday, he emphasized the need to balance emerging cracks in the labor market against upside inflation risks.
This further reinforced market confidence in a proven strategy: buying medium-term Treasuries. This approach provides interest payments while being less susceptible to price volatility caused by rapid reversals in economic outlook.
"In the long run, the economy will weaken, and rates will likely be lower," said Christian Hoffmann, portfolio manager at Thornburg Investment Management. However, he added that uncertainty remains because "it's becoming increasingly difficult to derive the Fed's reaction from data trends."
Over the past few months, hiring has slowed dramatically as US companies prepare for the impact of trade wars, providing support for the Fed to resume rate cuts. Simultaneously, other parts of the US economy remain resilient, and tariff policies could reignite inflation, which is already stubbornly above the Fed's 2% target.
At the press conference following last Wednesday's rate decision, Powell described the 25 basis point cut as "a risk management cut" and stated that policymakers would make decisions "meeting by meeting," despite their projections suggesting two more rate cuts this year.
Powell's comments disappointed some market expectations and pushed up yields across all maturities, as some investors had expected the Fed to initiate a more aggressive easing cycle.
Russell Brownback, Deputy Chief Investment Officer of Global Fixed Income at BlackRock, noted that market dynamics favor focusing on the so-called "belly of the yield curve," specifically around 5-year Treasuries. This segment has been among the best performers this year, with the Bloomberg 5-7 Year Treasury Index returning approximately 7%, outpacing the broader market's 5.4% gain.
Greg Peters, Co-Chief Investment Officer of PGIM Fixed Income, expressed similar views. He pointed out that these bonds offer sufficiently high fixed interest payments to profit through leverage, creating a "positive carry." Meanwhile, they also provide capital appreciation as maturity approaches. "Positive carry and roll-down return: this is a bond investor's dream," he said.
This strategy can partially buffer risks from inflation spikes or stronger-than-expected economic data that might force the Fed to change its policy path. The Fed's latest interest rate projections already show significant divergence in views.
Overall, projections indicate the Fed expects to cut rates by 25 basis points at each of the next two meetings in 2025, and by 25 basis points each in 2026 and 2027, which is less than what futures markets are pricing in.
Against this backdrop, some investors are unwinding trades previously established in anticipation of rate cuts. For instance, Natixis SA's strategy team ended its long recommendation on two-year US Treasuries last Thursday.
Andrew Szczurowski, portfolio manager at Morgan Stanley Investment Management, believes current market pricing may be more accurate than the Fed's projections. He thinks the Fed tends to protect the labor market and will continue reducing borrowing costs, providing room for the bond rally to continue.
Szczurowski's $12 billion Eaton Vance Strategic Income Fund has returned 9.5% this year, outperforming 98% of peers. "You did miss part of the rally, but there's still upside," he said. "This is a market for selective bond picking."