Investors shun long-term US bonds as hopes for aggressive Fed rate cuts fade

Reuters

5 hours ago

NEW YORK, June 16 (Reuters) - Bond investors, anticipating the Federal Reserve will hold interest rates steady again this week, are moving away from longer-dated Treasuries as they temper expectations for an aggressive easing given the lower chance of a U.S. recession.
Their flight away from the long end of the curve also reflects worries about President Donald Trump's tax and spending bill, which is being considered by the U.S. Senate.
On Wednesday, the U.S. central bank's policy-setting Federal Open Market Committee is widely expected to keep its benchmark overnight interest rate in the 4.25%-4.50% range at the end of a two-day meeting, as it tries to grapple with a mercurial Trump administration trade policy that could still boost inflation in the second half of the year.
But soft consumer and producer price readings in May, which so far have yet to show the effects of higher tariffs on inflation, have fanned expectations that the Fed could resume cutting rates soon.
Futures tracking the Fed's policy rate show higher odds that the central bank will deliver a pair of back-to-back rate cuts starting in September. Before the release of the latest inflation numbers, the market had priced in a cut in September followed by another one in December.
The Fed reduced rates three times in 2024 before pausing its easing cycle early this year.
"I don't necessarily want to go long duration," said Victoria Fernandez, chief market strategist and fixed income portfolio manager at Crossmark Global Investments in Houston.
While traders are betting the Fed's next rate cut will happen at its July or September meetings, Fernandez said she could see it happening "toward the very end of the year or even into next year."
Duration, expressed in number of years, shows how far the bond's value will fall or rise when interest rates move. In general, when rates fall, higher-duration bonds experience a greater increase in value compared to those with lower duration.
Long-duration bets typically involve buying assets on the back end of the curve on expectations of a decline in yields.
"There's a reason long rates (30-year Treasuries) are moving toward 5%, and that is because there's significant pressure in selling duration," said Neil Aggarwal, head of securitized products and portfolio manager at Reams Asset Management in Indianapolis.
"There are near-term concerns about volatility and from a short-term basis if you expect volatility to persist, it's difficult being long duration."
Thirty-year bond auctions were not well-received during the Treasury sales in April and May, amplifying the market's reticence about holding longer-dated debt. The long bond did see strong demand at last week's auction, helped in part by the rise in 30-year yields and easing volatility in the sector.
Positioning based on the latest J.P. Morgan Treasury Client Survey and active core bond fund indexes also suggested that long-duration positions have declined over the past two months.
Analysts said part of that move could be attributed to diminished expectations of a U.S. recession, which briefly increased in April following Trump's imposition of tariffs on imported products from around the world. Trump has since walked back most of the tariffs even as the U.S. and China affirmed a trade deal.
Goldman Sachs, for instance, last week trimmed its view of the probability of a U.S. recession in the next 12 months to 30% from 35% on easing uncertainty around Trump's tariff policies.
Trump's "One Big Beautiful Bill Act," which passed the U.S. House of Representatives and is being debated in the Senate, is likely to increase the deficit by $2.4 trillion over the next decade, Congressional Budget Office estimates showed, coming at a time when the U.S. debt as a share of gross domestic product has surged. Tariff revenue, however, should offset some of the deficit impact of the tax and spending bill, analysts said.
The prospect of even bigger deficits has added to concerns about the back end of the curve.
"There is a legitimate argument to expect steeper government curves in this cycle," said Danny Zaid, portfolio manager at TwentyFour Asset Management in New York.
Yield curve "steepeners" have been a popular trade since the Fed embarked on its easing cycle in late 2024. The strategy involves bullish bets on short-dated Treasuries, while reducing longer-dated exposure, which pushes yields on longer-dated Treasuries higher than short-term maturities.
"As investors, you should demand more compensation to fund a government that has a 120% debt-to-GDP ratio than a government that has 70% debt to GDP," Zaid said.
Investors are compensated with a higher yield for taking risk over a longer period.
"We think the curve can steepen some more," said Brendan Murphy, head of fixed income for North America at Insight Investment in Boston, referring to the five- to 30-year yield curve.
"We are overweight duration but concentrated more on the front end relative to the back end and more cautious about that 30-year part of the curve primarily due to uncertainty around the fiscal expansion and the potential for inflation to pick up due to some of this tariff policy."
Investors on Wednesday will also focus on the release of updated quarterly economic projections from Fed policymakers, including rate forecasts, which are issued in a chart known as the "dot plot" that reflects how much easing is expected. The "dots" from the March meeting showed a policy rate of 3.75%-4.00% by the end of 2025, or two quarter-percentage-point cuts.
Bond investors do not expect any changes to the Fed's policy rate forecast.