How Wall Street is Adapting to Potential Fed Rate Cuts
Across Wall Street, bond fund managers at firms like BlackRock and PGIM are adopting cautious strategies focused on delivering steady returns even as the Federal Reserve's policy path remains uncertain.
The Fed's first rate cut in nine months has already provided a solid boost to markets, propelling the U.S. Treasury market to its biggest annual gain since the pandemic forced the Fed to slash borrowing rates to near zero.
However, when Fed Chairman Jerome Powell finally made the widely anticipated move last week, he emphasized the need to balance risks stemming from a softening labor market against the potential for rising inflation. This has reinforced conviction in a winning strategy for navigating such uncertainty: buying intermediate-term U.S. Treasury bonds. These bonds offer regular interest payments and are less susceptible to price swings caused by rapid shifts in the economic outlook.
"The longer-term path is one of weaker economics and likely lower rates," says Christian Hoffmann, a portfolio manager at Thornburg Investment Management. But, he noted, there's plenty of uncertainty, adding, "It’s increasingly difficult to draw a straight line, from the evolution of the data to the Fed’s reaction."
The Fed's rationale for returning to rate cuts is supported by a sharp slowdown in hiring pace in recent months, as businesses prepare for the impacts of former President Trump’s trade war. At the same time, other parts of the economy have remained strong, and there's the potential for Trump's tariffs to reignite inflation, which remains stubbornly above the Fed’s 2% target.
At the recent press conference, Powell characterized the Fed's 25-basis-point rate cut as "risk management," and said policymakers would proceed "meeting by meeting," although their forecasts suggest the possibility of two more rate cuts this year. Those comments weighed on the bond market, pushing yields higher across the curve for the remainder of the week, as it tempered speculation that the central bank was preparing for a more aggressive series of cuts.
Russell Brownback, deputy chief investment officer for global fixed income at BlackRock, stated that the current dynamics favor the so-called "belly" of the yield curve, meaning bonds with maturities around 5 years. This has been one of the strongest-performing parts of the market this year, with the 5- to 7-year Treasury index returning about 7%, outpacing the broader market’s 5.4% rise.
"The middle part of the yield curve is the sweet spot," he said.
Greg Peters, co-chief investment officer of fixed income at PGIM, echoed this sentiment. He said the fixed-interest payments on these securities are high enough to profit by borrowing money to buy them, known as positive carry. As the securities approach their maturity date, they also offer capital appreciation.
"Positive carry and roll-down yield, that's the bond investor's dream," he said.
This approach provides a degree of insulation from the risk that an inflation spike or stronger-than-expected economic data would cause the Fed to change course.
The Fed's updated rate forecasts already show a wide divergence of views. Overall, they suggest officials largely expect the Fed to continue cutting rates at the next two meetings, and anticipate one additional 25-basis-point cut during 2026 and 2027, less aggressive than what’s priced into the futures markets.
This has prompted some to unwind their pre-rate-cut rally trades, with Natixis's strategy team closing its long recommendation on two-year U.S. Treasuries last week.
Andrew Szczurowski, a portfolio manager at Morgan Stanley Investment Management, said that current market pricing is likely more accurate than the Fed’s forecasts. He said he expects the Fed to choose to protect the labor market by continuing to lower borrowing costs, providing some room for the bond market to extend its gains.
The $12 billion Eaton Vance Strategic Income fund managed by Szczurowski has returned 9.5% this year, outperforming 98% of its peers. He said he’s been telling clients, "You’ve missed part of the rally, but there’s still upside, and next is a stock picker’s market."
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