Ahead of the US Fed's interest rate meeting this week, Wall Street bets that Powell would not "act rashly"

There are signs that bond investors are adopting a neutral stance ahead of the US Fed's two-day monetary policy meeting starting this Tuesday, reflecting ongoing market concerns that Trump's trade policies could drag the world's largest economy into a stagflationary scenario.

Many fixed-income market traders have indicated that their current operations either maintain alignment with benchmark duration, reduce exposure to long-end duration, or lean more towards holding assets on the short end of the yield curve.

"We are in a precarious equilibrium: on one hand, economic concerns are intensifying, with soft data indicators continuing to deteriorate; on the other hand, policy shocks could also impact inflation prospects and deficits," noted Chip Hughey, Managing Director of Fixed Income at Truist Advisory Services, a US trust institution.

For these fixed-income traders, maintaining neutrality means matching portfolio duration to the benchmark. For instance, if the benchmark duration is five years, a neutral operation would involve allocating to fixed-income assets with a five-year or similar maturity.

Duration, measured in years, is an indicator of the sensitivity of bond prices to changes in interest rates. Typically, when interest rates decline, the prices of high-duration bonds rise more significantly.

Previously, bond market investors had extended duration for most of 2024, betting that the Fed would initiate a deep interest rate cut cycle. Long-end bets typically involve buying longer-term bonds based on expectations of declining yields.

Powell unlikely to "make a hasty move"

Currently, the market widely expects the Federal Open Market Committee (FOMC) to maintain the target range for the federal funds rate at 4.25%-4.50% at this week's policy meeting. The unexpectedly strong April non-farm payrolls data released last Friday provided the Fed with room to hold steady.

Since the Fed's March policy meeting, the trade war initiated by the Trump administration has caused a sharp increase in the US's real effective tariff rate, particularly on Chinese goods. This sparked a wave of US Treasury bond selling—between April 3-11, the benchmark 10-year US Treasury yield surged 70 basis points to around 4.6%, before temporarily pulling back to around 4.357%.

Many market participants anticipate that Fed Chairman Powell may hint at the post-meeting press conference this week that Trump's tariff shocks could lead to higher inflation and unemployment, and that fears of an economic recession are not far-fetched.

An analysis team led by Michael Gapen, Chief US Economist at Morgan Stanley, wrote in a recent research report, "Given the resilience of inflation expectations and the potential for tariff shocks to trigger persistent inflationary effects, the Fed is unlikely to take preemptive action."

Since Trump's self-proclaimed "Emancipation Day" for reciprocal tariffs on April 2, he has rolled back some US tariffs, temporarily stabilizing the bond and stock markets. However, investors indicate that overall market anxiety about what comes next has not dissipated.

Gregory Peters, Co-Chief Investment Officer of PGIM Fixed Income, which manages $837 billion in assets, stated, "We advise investors to remain cautious and reduce risk exposure."

"From the perspective of the yield curve shape, the distribution of tail risks is skewed—I see no upside room and prefer to focus on the short end, as its movements are dominated by Fed policy," Peters explained, adding that the long end, particularly 30-year bonds, is driven by "factors beyond our control and comprehension."

However, the market does not expect the Fed to maintain interest rates unchanged for long. According to calculations by LSEG, the benchmark federal funds futures market has priced in nearly an 80% probability of the Fed restarting interest rate cuts at its July 29-30 policy meeting.

Meanwhile, the market expects approximately 75 basis points of interest rate cuts for the entire year—equivalent to three 25-basis-point cuts.

JPMorgan's latest US Treasury client survey shows that 64% of US bank clients hold a neutral stance, while 24% are net long overall. Jay Barry, Head of Global Interest Rate Strategy at JPMorgan, noted that this net long position in Treasuries is below the peak of 32% seen in the week of April 7.

"We are currently maintaining a neutral stance, with a slight bias towards the short end of the curve, as we anticipate that future Fed rate cuts will support short-end bonds," said Anders Persson, Chief Investment Officer and Global Head of Fixed Income at Nuveen. "Given policy uncertainties and the lack of clear market guidance, we are reluctant to make large directional bets."