The bond market may be overly optimistic about the scale and pace of Federal Reserve interest rate cuts, according to Daniel Ivascyn, the chief investment officer at Pacific Investment Management Co. (Pimco) and manager of the world’s largest actively managed fixed-income fund.
Current market sentiment has priced in around 113 basis points of Fed rate reductions for this year, with swaps rates indicating expectations of a potential half-point cut during one of the three remaining meetings in 2024, beginning with Wednesday’s decision. Over the next 12 months, traders are betting on more than 240 basis points in total cuts, a pace rarely seen outside of recessionary periods.
Ivascyn, who manages the $163 billion Pimco Income Fund, expressed concerns about these market expectations during a recent appearance on Bloomberg’s “Odd Lots” podcast. “The markets may be getting a little bit ahead of themselves in terms of near-term cuts,” he said. Ivascyn also pointed out the possibility of inflation reaccelerating over the coming months, potentially resulting in fewer rate cuts than currently priced into the market.
To navigate this landscape, Ivascyn is adjusting the fund’s strategy by reducing exposure to short-term notes due in one or two years and favoring five-year maturities. He noted that the yields on policy-sensitive two-year Treasury notes have declined to around 3.6%, down from approximately 5% in late April. In comparison, five-year notes are yielding about 3.5%.
Pimco’s strategic approach has paid off, with the Income Fund delivering an average annual return of 3.6% over the past five years, outperforming the Bloomberg US Aggregate Total Return Index, which gained 0.6% in the same period.
The conversation took place just ahead of the Federal Reserve’s Wednesday decision, which is expected to announce the first rate cut in four years. Markets have fully priced in a 25-basis-point reduction, with a 55% probability of a half-point move. Despite this “close call,” Ivascyn argued that the exact size of the cut is not as crucial given the market’s recent behavior. With stocks hovering near all-time highs and credit spreads remaining tight, he believes financial conditions have already eased considerably, effectively doing “a lot of work for the Fed.”
He added that the Federal Reserve has ample tools at its disposal, allowing for flexibility in adjusting the pace of rate changes to avoid policy missteps. “Even if they get something wrong in a narrow sense, they can course correct to get the market back on track as necessary,” Ivascyn remarked, underscoring his view that the Fed has room to fine-tune its approach as conditions evolve.
Leave feedback about this