© Reuters. FILE PHOTO: An eagle tops the U.S. Federal Reserve building’s facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst/File Photo
By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) – Get ready, bond investors! The Federal Reserve is expected to drop its bias toward hiking interest rates at a policy meeting this week. This is to prepare the market for what could be multiple rate cuts this year, the first since the start of the COVID-19 pandemic in 2020.
Portfolio managers are ramping up bets on long-duration U.S. Treasuries prior to the meeting. This reflects expectations that yields on those securities will decline as the U.S. central bank moves toward cutting rates. As the economy slows, longer-duration bonds tend to outperform other assets.
In general, bonds with long maturities and low coupons have the longest duration. These bonds are more sensitive to changes in interest rates.
“We have throughout the past year suggested extending duration in anticipation of the cycle turning,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research in New York.
The Fed is widely expected to hold interest rates steady at the end of its two-day policy meeting on Wednesday, with some investors seeing a possibility that it could ramp up its dovish tone after it was perceived to have pivoted from a tightening policy outlook at its meeting last month.
Seventeen of 19 Fed officials projected at the Dec. 12-13 meeting that the policy rate would be lower by the end of this year, compared to where it was last month. The Fed’s median projection showed the rate falling three-quarters of a percentage point from the current 5.25%-5.50% range.
Guneet Dhingra, managing director and head of U.S. rates strategy at Morgan Stanley in New York, said the Fed could talk more this week about an easing bias. “The only question is how quickly it starts and how fast the easing is.”
In the rate futures market, rate cut bets were a little more aggressive. Federal funds futures, a straightforward measure of where traders believe the U.S. central bank’s benchmark overnight interest rate will be at any given time, have priced in five 25-basis-point cuts for 2024, according to LSEG’s rate probability app.
The market is pricing in the first rate cut to occur at the April 30-May 1 meeting, with a 91% probability. Futures showed less than a 50% chance of a cut at the March 19-20 meeting. Odds of a cut in March were as high as 80% three weeks ago.
LONG DURATION
“We have moved to longer duration for all the portfolios we manage,” said Jeff Klingelhofer, co-head of investments at Thornburg Investment Management in Santa Fe, New Mexico, with around $43 billion in assets under management.
“The bar for reverting back to higher rates is quite high and we’re unlikely to go there,” he added, noting that given how aggressive the Fed’s rate hikes have been over the last two years.