Before the Federal Reserve commenced its two-day monetary policy meeting this Tuesday (May 6), the U.S. Treasury market entered a state of heightened caution. Investors generally adopted a neutral stance, reflecting deep-seated concerns that Trump's trade policies might trigger a "stagflation" scenario.
Several fixed income market participants have expressed that they currently prefer to align their portfolio duration with the benchmark or actively reduce long-end duration exposure to mitigate the uncertainties surrounding policy and economic prospects.
Chip Hughey, Head of Fixed Income at Truist Advisory Services, noted: "We are in a precarious equilibrium. Economic data continues to weaken, and policy disruptions could further exacerbate inflation and fiscal deficit situations."
Neutral Duration Operations are Mainstream
The so-called "neutral duration" means that the duration of bonds held by investors matches the market benchmark to avoid significant price fluctuations due to interest rate changes. For example, if the benchmark duration is five years, holding five-year bonds is considered a neutral operation. Throughout most of 2024, investors had widely bet on Federal Reserve rate cuts, actively extending durations. However, the trend is now subtly shifting.
Trump's Tariff Impacts Induce Market Volatility
Since Trump announced a reciprocal tariff "liberation day" on April 2, U.S. tariff levels swiftly increased, particularly targeting Chinese goods, causing significant fluctuations in the bond market. Between April 3 and 11, the 10-year U.S. Treasury yield surged 70 basis points to 4.6%, and then slightly retreated, currently hovering around 4.36%.
Although some tariff measures were retracted later, temporarily stabilizing the market, investors remained vigilant. Gregory Peters, Co-Chief Investment Officer of PGIM Fixed Income, advised clients to continue avoiding risks, focusing on the short end.
The Fed to Stand Pat, But Powell May Signal Stagflation Risk Warning
The Federal Open Market Committee (FOMC) is widely expected to keep the federal funds rate range unchanged at 4.25%-4.50% in this meeting. The robust April non-farm payroll data released last Friday further provided room for the Fed to maintain stability.
Morgan Stanley's economics team warned that Trump's tariff impacts could lead to rising inflation and increased unemployment, making it harder for the Fed to take preemptive rate-cut measures. Chairman Powell is expected to express economic concerns with caution during the post-meeting press conference.
Market Still Sees Room for Rate Cuts This Year
Despite the current policy holding steady, federal funds futures indicate that the market has priced in nearly an 80% chance of a rate cut by July. The total rate cut for the year is still expected to be 75 basis points, equivalent to three rate cuts.
The latest JPMorgan client survey shows that 64% of U.S. Treasury investors hold neutral positions, with only 24% net long, down from a high of 32% in early April, indicating a shift towards cautious market sentiment.
Anders Persson, Head of Global Fixed Income at Nuveen, also stated that the company currently maintains a neutral to short duration configuration due to chaotic policy signals and a lack of market direction. "In this environment, we do not intend to make large directional bets."
Outlook: Caution Prevails, Focus on Fed Statements and Tariff Developments
Overall, bond market investors are constructing defensive investment strategies, awaiting further statements from Fed Chairman Powell and subsequent tariff policy implementations. If tariffs continue to fuel inflation expectations, short-end assets may benefit; however, if the Fed's policy adjustment pace is delayed, long-end yields may face further volatility. In the coming months, the U.S. Treasury market will continue to be dominated by multiple factors, including macroeconomic data, fiscal policy directions, and global trade conditions.
