Bond investors go for safety, brace for ultra-hawkish Fed

NEW YORK, May 2 - The Federal Reserve's well-telegraphed plan to hike interest rates by half a percentage point on Wednesday and start reducing its balance sheet has failed to ease inflation and growth worries, prompting bond investors to seek safety by adjusting the duration of their portfolios.

Safety trades can mean going short or long duration depending on the perceived risk, asset managers said.

With the U.S. central bank fighting to stem soaring inflation, fed funds futures, which track short-term rate expectations, have priced in at least three 50 basis-point increases this year, with more than 250 basis points in cumulative hikes .

By the end of 2022, the market has priced in a fed funds rate of 2.86%, compared with the current 0.33%.

The Fed is expected to yank two legs out from under the punch bowl, by raising rates again and allowing its nearly $9 trillion balance sheet to shrink by as much as $95 billion per month starting in June, a two-fisted approach that has never been attempted with such intensity. read more

Ahead of the Fed meeting, many bond investors have maintained holdings of short-duration fixed-income securities, typically anywhere between one- to three-year maturities, as they hedge against an aggressive pace of Fed tightening. Shorter-duration bonds, in general, outperform longer-dated ones in a rising rate environment.

Some investors such as Insight Investment have also opted to go neutral when it comes to duration risk, after being underweight this benchmark for some time.

"There's still a fair amount of uncertainty," said Jason Celente, senior portfolio manager at Insight Investment.

"Will inflation come down? Will the Fed err on the side of running inflation a little bit hotter than what it has been in the past? We think that's probably going to take a little bit of time to play out."

REUTERS