Robert:
Big movement yesterday1 with the Federal Reserve (the Fed). Rates are always a huge topic in our business. Walk us through what happened.
RJ:
I don’t think the Fed surprised anyone yesterday. Markets were well-prepared for a 25-basis point cut, and that’s exactly what we got. In fact, markets had started to position for what they called a “hawkish cut” – a rate reduction paired with commentary suggesting the Fed was done easing or that inflation was becoming a bigger concern.
Instead, Chair [Jerome] Powell painted a different picture at the podium. He seemed to weigh slowing job creation more heavily than lingering inflation concerns. As a result, market yields came down slightly.
I still think there was a tone suggesting we might not see another Fed ease under Powell’s leadership. He’ll be done this spring and likely replaced by [Kevin] Hassett – though Trump can be mercurial. Ultimately, I think the bond market is probably set for a bit of a range trade where the impetus that we’ve had of Fed cuts to draw yields lower is probably fading. Want to see what Hassett embraces? He will probably be more dovish than Powell, but it’s clear that the policy outcome is a process of a committee – Hassett can’t just come in there and declare it so.
I think the bond market is probably set for a range trade so long as the economy holds up. The impetus from Fed cuts that pushed yields lower is fading. I think in 2026 the base case is we should expect some fiscal expansion, the probability of recession seems low, and the Fed is probably done easing for a while.
Ultimately, I think the bond market is probably set for a bit of a range trade where the impetus that we've had of Fed cuts to draw yields lower is probably fading.
Robert:
You mentioned the end of Powell’s tenure. I thought it was interesting that he spent time on that in the Q&A. My take was that he prioritised addressing job weakness over inflation.
RJ:
That’s a good point. Nobody wants to finish their Fed tenure, whether they’re a governor, and certainly not the Chair, during a recession. Powell’s goal is to support a healthy economy and keep unemployment rate at 4%. The summary or economic projections continues to forecast unemployment moving back down, even though it’s been edging up recently.
Robert:
How does this relate to our investment process? Duration and yield curve are big parts of that. You’ve managed duration well in 2025 by staying slightly longer as rates came down. Do you see that changing in 2026?
RJ:
Leaning longer on duration worked because the economy, while resilient, faced shocks – like the Liberation Day tariffs – which challenged financial assets. Those tariffs ended up higher than expected, and firms slowed hiring. The job creation data opened the door for the Fed to ease three times this year. As a result, the bond market had some wind at its back, and we’ve had strong total returns.
The Aggregate Index is up about 7% year-to-date – a solid number historically. If you flip the page to next year, there are challenges. Firms will likely remain reticent on the hiring front. On the other hand, there is fiscal policy expansion and inflation is still warm.
So, the duration trade may not be as compelling. Within our investment process, the yield curve steepening is something we’ve also played through Don Ellenberger’s (Head of Multi-Sector Strategies Group) committee. That theme still has room to develop in 2026. It might not happen in Q1, but I wouldn’t be surprised if the curve continues to steepen – in fact, we face the possibility of a “twist steepening” where long-term yields rise.
The US government still bleeds a lot of red ink and is issuing a lot of debt, and concerns about Fed independence could push risk premiums higher. If the Fed resumes easing later in 2026, long-term yields might stay elevated, steepening the curve. Or it makes the duration trade, which is focusing on sort of the average yield of the index, perhaps not as compelling as the steepness. The question is also of the timing of the steepening as the year unfolds.
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