(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.
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.
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.
"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.
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. The five-year bond offered a yield of 4.15% in the morning session in Asia on Monday.
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.
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.
"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."
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.
Even as traders trimmed back their pricing of rate hikes in recent sessions, there remains a wariness that should forthcoming data show inflation isn't moderating — it's been running above the Fed's target for years now — the central bank will likely push through hikes starting as soon as September. The pressure in Treasuries will be led by the policy-sensitive two-year, with longer-dated yields likely to lag as the prospect of tighter Fed policy is seen prompting weaker growth in 2027.
"If the Fed hikes in 2026, they unwind later in 2027," said John Briggs, head of US rates strategy at Natixis North America. As a result, he said he prefers the "belly a bit more to get a bit more of time to price in the potential cuts."
It's a view recently endorsed by PGIM, with the asset manager expecting three hikes this year, followed by a series of eases in 2027 into 2028.
What Bloomberg strategists say ...
"Five-year Treasuries sit at the intersection of Federal Reserve policy and inflation expectations. As such, recent price action reflects confidence in a fading energy shock at the same time as the view that inflation can moderate without a meaningful deterioration in growth gains traction."
—Alyce Andres, macro strategist, Markets Live. For the full analysis, click here.
Other investment houses have largely stuck to their calls even as market pricing turned more hawkish. For bond giant Pimco, that includes positioning in the belly.
"Our base case disagrees with the market as we don't believe that the Fed will raise rates because the economy should slow in the second half of this year and buy time for them to stay on hold," said Michael Cudzil, senior portfolio manager at Pimco.
The $2.3 trillion asset manager is overweight interest-rate exposure and owns both the front end and the belly, or twos through fives — an area Cudzil says has only grown more attractive after the recent selloff.
"It's very possible that front end and belly yields fall below 4% in the second half of the year, if the market takes out hikes and then starts talking about potential easing," he said. "Market narratives can turn pretty quickly and all it takes is a couple pieces of data to see a bit of a wobble."
What to Watch
- Economic data:
- June 29: Dallas Fed manufacturing activity
- June 30: FHFA house price index; S&P Cotality CS US 20-City and HPI; MNI Chicago PMI; Conference Board consumer confidence and expectations; JOLTS job openings and quits rate; Dallas Fed services activity
- July 1: MBA mortgage applications; ADP employment change for June; Challenger job cuts; S&P Global US manufacturing PMI; ISM manufacturing; construction spending; Omida total vehicle sales
- July 2: Non-farm payroll report for June, unemployment rate, average hourly earnings; Initial jobless claims; factory orders; durable goods orders; capital goods orders
- Fed calendar:
- July 1: Fed Chairman Kevin Warsh at Sintra panel; Warsh on ECB panel at Sintra
- July 2: San Francisco Fed President Mary Daly speaks in a moderated discussion at Banco de España conference in Santander, Spain
- Auction calendar:
- June 29: 13-, 26-week bills
- June 30: 6-week bills
- July 1: 17-week bills
- July 2: 4-, 8-week bills
--With assistance from Matthew Burgess.
(Updates market pricing in fifth paragraph)
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