US Bond Investors Bet On Mild Easing Cycle, Stick To Middle Of Curve

• Bond investors are positioning for a shallow easing cycle from the Federal Reserve as it gears up for its final policy meeting of 2025, reducing exposure to long-duration Treasuries and rotating into intermediate maturities for juicier returns. Many Wall Street banks have penciled in fewer Fed interest rate cuts in 2026 on lingering inflation concerns and expectations of a more resilient U.S. economy.
• Against that backdrop, the shift to the so-called belly of the curve - such as U.S. five-year Treasuries - reflects a view that the typical strategy of loading up on long bonds during rate-cutting cycles may not deliver the same payoff this time. The thinking hinges on inflation and the Fed's evolving policy stance.
• The U.S. central bank's policy-setting Federal Open Market Committee is widely anticipated to lower its benchmark overnight rate by 25 basis points to the 3.50%-3.75% target range at the end of a two-day policy meeting that starts on Tuesday. Investors will also scrutinise the FOMC statement as well as Fed Chair Jerome Powell's post-meeting remarks for signals that the benchmark rate is close to neutral, the level at which monetary policy is neither accommodative nor restrictive, potentially near 3%.
• "We are expecting a shallow path of rate cuts, mainly because inflation is still too high and that's a concern for a lot of voting (FOMC) members especially for some rotating in next year. But the labor market is cooling, although not falling off a cliff," said Collin Martin, head of fixed income research and strategy at the Schwab Center for Financial Research.
• Barclays sees the Fed delivering two more 25-bp rate cuts, in March and June, while Deutsche Bank sees the Fed on hold in early 2026, but easing again in September under a new and more dovish leadership. HSBC, on the other hand, said the central bank will pause over the next two years after a rate reduction on Wednesday.
• When the Fed enters a rate-cutting cycle, investors typically extend bond duration, anywhere from 10-year to 30-year U.S. Treasuries. In periods of easing, shorter-dated yields fall, so investors reach further out the curve to lock in higher long-term rates before they decline further. As such, longer-dated debt has traditionally outperformed shorter-duration Treasuries when the Fed is cutting rates.
• With the inflation rate remaining above the Fed's 2% target, bond investors anticipate a higher neutral rate of possibly 3%. If the neutral rate is higher, the upside for long-duration bonds could be capped, making intermediate maturities or the belly of the curve a more attractive hedge against policy uncertainty and inflation persistence, analysts said.

(Source: Reuters)