U.S. bond investors are preparing for increased market volatility as uncertainty looms over the impact of the Trump administration’s policies and the Federal Reserve’s interest rate trajectory. With the Fed widely expected to pause rate cuts this week, portfolio managers are taking a defensive stance and avoiding long-term bonds.
Investors Stay Cautious on Long-Term Bonds
Bond investors have shied away from long-term Treasuries (10-year and 30-year bonds) ahead of the upcoming Fed policy decision. Many have also adopted a more neutral positioning relative to their benchmarks due to growing uncertainty surrounding interest rates in 2025.
The Federal Open Market Committee (FOMC) is expected to maintain the benchmark interest rate in the 4.25%-4.50% range at the conclusion of its two-day policy meeting on Wednesday. Fed Chair Jerome Powell is likely to maintain a cautious stance and keep policy options open as the central bank assesses how Trump’s fiscal policies may reshape the economic landscape.
Inflation and Fiscal Risks Cloud Outlook
Despite slowing inflation, the Fed faces new risks that could lead to price pressures:
- Trump’s proposed tariffs on imported goods could drive inflation higher.
- Mass deportations of undocumented immigrants may create labor shortages, pushing up wages.
Given these uncertainties, Byron Anderson, head of fixed income at Laffer Tengler Investments, warned against long-term bond exposure:
“Adding duration into the unknown is probably a bad idea, especially as we have no clue what’s going to happen over the next year.”
Shift in Bond Market Positioning
Last year, investors flocked to long-duration bonds expecting an aggressive rate-cutting cycle. However, the last quarter of 2024 saw a retreat from long-duration positioning as expectations of deep Fed rate cuts faded.
In January, as the 10-year Treasury yield hit a 14-month high of 4.809%, active investors cautiously added duration, according to JPMorgan’s Treasury Client Survey. The survey also revealed a shift toward a more neutral stance on bonds, with fewer investors holding overweight positions.
More Neutral Positioning Among Investors
Many bond investors are taking a more balanced approach to their portfolios:
- Mike Sanders, head of fixed income at Madison Investments, stated:
“We are close to neutral duration, with most of our overweights in the three- to five-year part of the curve.” - Sanders also expressed skepticism about aggressive Fed rate cuts:
“I don’t see the Fed cutting more than twice this year unless there’s a significant economic slowdown.”
Market Reaction to Tech Selloff
Monday’s selloff in technology stocks triggered a decline in Treasury yields, leading the bond market to price in two Fed rate cuts for 2025. Prior to this, markets had anticipated just one rate reduction.
The Fed’s own December forecast signaled two quarter-point rate cuts in 2025, with the benchmark rate expected to end the year in the 3.75%-4.00% range.
Rising U.S. Fiscal Deficit Weighs on Bonds
The U.S. fiscal deficit remains a growing concern for bond investors:
- The deficit has doubled from 3.1% of GDP in 2016 to over 6% of GDP in 2024.
- Brian Ellis of Morgan Stanley Investment Management warned that the flood of new Treasury issuance will need to be absorbed by price-sensitive buyers:
“We have much less conviction and are underweight on the long end of the curve due to fiscal policy risks.”
Outlook: Treasury Yields and Market Uncertainty
Analysts estimate that $14.6 trillion in Treasuries will be issued over the next two years. However, the Federal Reserve, once a major buyer of bonds, is no longer absorbing the bulk of this supply, which could push Treasury yields even higher.
Guneet Dhingra, head of U.S. rates strategy at BNP Paribas, emphasized the market’s focus on fiscal policy:
“The market is more focused on fiscal policy now. Monetary policy reactions are secondary.”
Given the heightened uncertainty, Dhingra suggested a cautious approach:
“It’s a good time to be neutral in the Treasury market because uncertainty is extremely high.”
Conclusion
With the Fed likely to hold rates steady and uncertainty surrounding Trump’s fiscal policies, bond investors are taking a defensive stance. While Treasury yields remain in focus, concerns about inflation, deficits, and government spending continue to drive cautious positioning in the bond market.
