US Treasuries continue to move lower as hopes for a pivot in Fed policy are eroding. From the start of the year, the yield on the 10-year has climbed from 3.9% to above 4.3% to reach their highest levels since November. In total, it has retraced nearly half of the rally that began in October of last year. 


Over this period, the number of rate cuts expected in 2024 has declined from 6 to 3 as has the timing. Primarily, this is due to the economy remaining strong as evidenced by the labor market and inflation that has proven to be more entrenched than expected. All in all, the narrative has certainly changed as some now believe the Fed may actually hike rates further especially as there are indications that the steady decline in inflation has ended. 


Minutes from the last FOMC meeting also showed that committee members are concerned about the risk of inflation re-igniting if it begins to cut too soon. Overall, it remains ‘data-dependent’. However, all the recent data has undermined the case for immediate or aggressive cuts. According to Rich Familetti, CIO of US fixed income at SLC Management, the current Fed stance "is going to make it very hard for rates to fall much further from here… The pain trade is at higher rates and we will likely experience that."

Finsum: Treasuries continued their losing streak as higher interest rates have weighed on the entire fixed income complex. The market is now expecting 3 cuts in 2024 down from 6 at the start of the year.


With a strong recovery in fixed income over the past couple of months, fixed income fund managers are looking to generate inflows from the nearly $6 trillion that is sitting in money market funds. Some portions will certainly move into fixed income especially if interest rates start to move lower, and investors look to move further out on the curve to take advantage of still attractive yields.


Due to this, active fixed income funds delivered their biggest monthly returns in decades, leading to a surge of inflows. Recent economic data and chatter from FOMC officials have also been supportive of the asset class.


The challenge for managers is the explosion in active fixed income funds over the last few years, leading to price wars for market share and consolidation. Many are from the largest asset managers like Vanguard, State Street, and Blackrock, which have very low costs. Funds that aren’t able to sufficiently attract inflows over this period will only face more difficulties in the future in remaining viable. 


According to Rich Kushel, the head of Blackrock’s portfolio management group, “We are in a winner-takes-a-lot moment. If you’re truly adding real alpha, there will always be a place for you in this industry. For the folks who haven’t, you might as well buy [the benchmark].”

Finsum: There is nearly $6 trillion on the sidelines. Some of this will move into fixed income especially if rates start dropping. There will be intense competition among active funds to be a recipient of these inflows. 


PIMCO sees a changed environment in 2024 as the Fed will pivot to rate cuts. However, it sees the impact of prior rate hikes still impacting economies and leading to stagnation or a mild contraction. 


Financial markets will be focusing on the timing and pace of rate cuts. Based on history, central banks don’t ease in anticipation of economic weakness. Instead, they tend to cut only after recessionary conditions materialize and tend to cut more than expected by the market. 


PIMCO agrees with Chair Powell that inflation and growth risks are now more ‘symmetrical’. However, it believes the market is underpricing recession risk especially given that some assets are already priced for a soft landing given the strong rally in many assets over the past few months. 


It also believes that fixed income is particularly appropriate for this environment given that yields are still close to multi-decade highs. It also offers protection and upside in the event of economic conditions deteriorating. Within the asset class, it favors mortgage-backed securities and believes investors should stick to medium-duration bonds as yields are attractive while interest rate risk is reduced. On a longer-term basis, PIMCO sees neutral policy rates to reach similar levels to before the pandemic which is also supportive of the category. 

Finsum: PIMCO sees financial conditions easing in 2024 as the Fed cuts rates, but economic conditions will deteriorate given the delayed impact of tight monetary policy.


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