Preparing your bond portfolio for the Fed’s next moves

THE US Federal Reserve is widely expected to resume cutting interest rates. At the time of writing, market pricing indicates a 90 per cent probability of a 25 basis point (bp) cut and a 10 per cent probability of a larger 50 bp cut in September, with nearly 75 bps in total cuts priced in for 2025.

At the Jackson Hole symposium in August, US Federal Reserve chairman Jerome Powell signalled greater openness to rate cuts, citing downside risks to the labour market. Since then, cracks in US employment have continued to emerge. Unemployment has edged higher, while non-farm payroll figures have seen large downward revisions. The latest downward revisions show that the US economy may have lost 13,000 jobs in June, its first monthly job loss since 2020.

Tough decision for the Fed

While the weakening employment picture supports a rate cut, inflation complicates the picture. Price pressures in the US remain persistent, with inflation showing signs of re-acceleration, partly driven by tariff pass-throughs, as well as non-tariff causes such as rising shelter costs.

Furthermore, survey-based inflation expectations remain elevated, raising questions on whether inflation is truly well-anchored. While inflation prints have been manageable in recent months, markets may be underpricing the risk of renewed price pressures.

This leaves the Fed with a tough decision on its dual mandate, with signs of a softening labour market on one side, and stubborn inflationary pressures on the other. Looking forward, we see a higher likelihood of rate cuts but expect any Fed cuts to be gradual.

Against today’s uncertain backdrop, not least with tariff negotiations still in flux, aggressive or premature rate cuts could set Fed policy back. Premature cuts would risk sending the wrong signal to markets that the Fed now views inflation as a secondary concern, and may rekindle price pressures by stimulating the economy at a time when upside risks to tariff-related inflation are high.

Good risk-reward in short to medium-term bonds

Given our view on rates, we continue to favour bonds at the front-end and belly of the yield curve. Medium-term government and corporate bonds offer modest yield pickups over shorter-term bonds and are good options for income-focused investors to lock in yields with a decent balance between yield and duration exposure.

In the domestic Singdollar space, yields on the ultra-short end (below six months) have already fallen sharply, but select corporate bonds with longer tenors still offer good relative value with yields above 3 per cent. There has also been a steady stream of new bond issuances between the three-year and seven-year tenors this year, providing multiple opportunities for investors to lock in yields.

Meanwhile, in the US dollar space, ultra-short yields remain attractive at around the 4 per cent level, especially for investors seeking liquidity with very little risk. In addition, US dollar yield curves generally look steeper than their Singapore dollar counterparts, and hence offer better compensation for extending duration along the curve.

There is a wider selection of corporate bonds in the three to seven-year range of tenors with different credit qualities, and investors will have many choices regardless of their individual risk tolerance.

Not enough value in long-term bonds

We are also cautious on bonds with ultra-long tenors such as 30-year bonds today. This may seem counterintuitive in a rate-cutting environment, but we emphasise that rate cuts by the Fed primarily influence the front end of the curve. In contrast, yields at the longer end are often shaped by other factors such as geopolitics and fiscal developments, which can offset the downward pressure on yields from rate cuts.

Longer-term bonds also typically come with higher price volatility due to their greater duration exposures. For income-focused investors, we think medium-term bonds strike a better balance, offering decent yields without excessive duration exposure and volatility.

Nonetheless, tactical traders may still find ultra-long-term bonds interesting in active buy-and-sell strategies, as their larger price swings may create trading opportunities. For instance, the longest-tenor Singapore government bond saw a price dip of around 26 per cent between 2023 and 2024, before recovering most of these losses (around +35 per cent) in the subsequent period of more than a year.

This highlights the potential for large gains but also similarly large losses, making them suitable for investors with higher risk tolerance who may be looking to make short-term tactical bets.

Navigating an uncertain rate environment

While Powell has clearly signalled a path to rate cuts in 2025, we stress that the pace of the cuts remains in unclear. The US core personal consumption expenditure index continues to run above the 2 per cent target, and Powell himself has highlighted the risks that tariffs could “spur a more lasting inflation dynamic”.

We have favoured short-term bonds for some time, but we are also starting to see growing opportunities in medium-term bonds now.

There is a wide variety of products with short or medium-term fixed income exposures, ranging from corporate and sovereign bonds, exchange-traded funds, and unit trusts. With careful product selection, investors can optimise their fixed income exposures and build more resilient portfolios regardless of market conditions.

The writer is a senior analyst in the Bondsupermart team at iFast Financial, the Singapore subsidiary of iFast Corporation