Bond Heavyweights Target a Market Sweet Spot for New Warsh Era

Kevin Warsh Photographer: Al Drago/Bloomberg Photo by Al Drago /Photographer: Al Drago/Bloomberg

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(Bloomberg) — Some of the biggest bond managers are zeroing in on one specific area of the market as the best place to ride out the early days of the Kevin Warsh era.

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From Capital Group to Insight Investment, Natixis and Pacific Investment Management Co., the message is the same: The sweet spot is the “belly,” or the five-year area of the Treasury curve, and they’re all piling in.

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Investors are gravitating to those maturities as Treasury yields stabilize after spiking earlier this month on Fed Chairman Warsh’s hawkish pronouncements on restoring price stability. Rebounding from those losses, US bonds notched steady gains last week as oil prices declined and traders ratcheted back some of their more aggressive wagers on interest-rate hikes for this year into 2027. 

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“The five year is a nice balance” and a “good pivot point,” said Brendan Murphy, head of fixed income for North America at Insight Investment, a global asset manager with some $836 billion under management.

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With Fed officials split over whether to stay on hold or hike at least once this year, the five—year maturity appeals because it’s seen as a proxy for the bigger economic picture, taking in a longer period that can include both easing and hiking cycles. That’s unlike the two-year note, which is primarily driven by shorter-term rate wagers. And it carries less risk than inflation-sensitive long bonds, while still offering a generous yield, at 4.13% as of Friday. 

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Buyers of the belly say they are mindful that the bond market narrative is fluid and prone to shifts. Rate cuts could easily re-enter the conversation even though hikes have been the main topic lately. Already, activity in the past week shows traders toning down their hawkish stance, pricing in one to two rate increases by the middle of next year as a peak for Fed tightening after earlier positioning for a series of hikes starting as early as next month. 

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Intermediate maturities around the five-year area may also offer shelter from any volatile reactions to upcoming data, such as the June monthly jobs report on Thursday, followed by inflation prints next month. The Treasury market will be closed Friday in observance of the Independence Day holiday.

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“The front end of the curve will be more volatile, which is why I prefer intermediate rates,” said Chitrang Purani, a portfolio manager at Capital Group, which has more than $3 trillion under management. “The inflation trajectory and growth resilience that we’ve seen year to date does justify the move higher in interest rates, but looking forward, the drivers of economic growth remain uneven and inflation has not yet been led by demand-side factors.” 

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Another selling point for the belly? It’s a relative bargain, as highlighted by a measure that shows five-year notes have underperformed both shorter- and longer-dated maturities. The so-called butterfly — a gauge of where the five-year Treasury yield stands relative to its two- and 30-year counterparts — is trading near its highest level in more than a year.