Amid a hawkish pivot under new Federal Reserve Chair Kevin Warsh, some of the world's largest bond management firms are focusing on the "belly" of the U.S. Treasury yield curve, specifically five-year notes, viewing it as the optimal position to navigate current policy uncertainty.
From Capital Group to Insight Investment, and from Natixis to Pacific Investment Management Company (Pimco), the message is consistent: the five-year sector is the best place to be in the early stages of the Warsh era. As Treasury yields stabilized following Warsh's hawkish comments at the June FOMC meeting, coupled with falling oil prices and traders scaling back aggressive rate hike bets, these giants are accelerating their shift toward intermediate-term bonds.
As of last Friday, June 26, the five-year Treasury yield stood at 4.13%. This figure offers a blend of yield and defense—high enough to provide a substantial coupon, yet sufficiently in the "middle" to avoid the extreme risks at either end of the curve.
Why the "Belly" Strategy is Gaining Consensus: The Triple Logic of the "Sweet Spot"
Spanning the Cycle: Accommodating Both Hikes and Cuts
The appeal of five-year U.S. Treasuries in the current environment stems from their unique risk-return profile. They sit at the intersection of Fed policy rate expectations and long-term inflation expectations, being neither as hypersensitive to short-term rate moves as the two-year nor as exposed to significant inflation and term premium risks as the thirty-year.
Brendan Murphy, Head of North American Fixed Income at Insight Investment, stated directly: "The five-year is a great balance point" and "a great inflection point." This global asset manager, overseeing roughly $836 billion, believes intermediate-term bonds can lock in attractive yields while avoiding excessive interest rate volatility.
Chitrang Purani, a Portfolio Manager at Capital Group, offered a more detailed explanation: "The front end of the yield curve is more volatile, so I prefer the middle part of the curve." He noted, "The inflation trajectory and economic resilience year-to-date certainly support rate hikes, but looking ahead, the drivers of economic growth remain uneven, and inflation is not yet being driven by demand-side factors." Capital Group manages over $3 trillion in assets.
Risk-Reward Ratio: Avoiding Traps at Both Ends
Short End (2-year): Highly dependent on the Fed's policy path, extremely sensitive to every official speech and economic data point. Volatility in this segment has surged since Warsh abandoned forward guidance.
Long End (10-year, 30-year): Highly sensitive to inflation expectations and term premium. Warsh's plan to restructure the Fed's balance sheet and gradually reduce holdings of mortgage-backed securities (MBS) is altering the supply-demand dynamics for long-dated Treasuries.
Middle (5-year): Neither overly exposed to policy noise nor excessive inflation risk, making it the "safest" duration exposure.
John Briggs, Head of U.S. Rates Strategy for North America at Natixis, explained the belly's advantage from a policy cycle perspective: "If the Fed hikes in 2026, they will exit those hikes later in 2027." Therefore, he prefers "the market to be a little bit easier to give more time to digest potential easing expectations."
Dan Ivascyn, Group Chief Investment Officer at PIMCO, sent a clearer signal during a mid-June media roundtable. He pointed out that the most attractive opportunity in the bond market currently is the five-year U.S. Treasury. "The risk for cash investors is that there could be some unforeseen shock to growth," Ivascyn warned. "You might think you're going to get about 4% on cash for the next five years, and then suddenly rates go to 2% and you're stuck earning 2% for the rest of your time." Extending the investment horizon to five years allows investors to lock in a higher yield for a longer period—the current five-year yield is around 4.2%. PIMCO, managing about $2.3 trillion, is overweight interest rate exposure, holding the front and middle parts of the curve (i.e., 2 to 5 years).
Relative Value: Butterfly Spread at Its Highest in Over a Year
Another major attraction of five-year Treasuries is their relative cheapness. The so-called "butterfly yield"—a measure of the five-year yield relative to the two-year and thirty-year yields—is currently near its highest level in over a year.
This implies that, from a relative value perspective, five-year Treasuries are undervalued. By the end of May 2026, the spread between five-year and thirty-year Treasuries had narrowed to about 81-82 basis points, reflecting investors' relatively lower demand for term premium in the middle segment. Previous analysis from Goldman Sachs also noted that, based on butterfly spread models, the yield on the five-year sector is at historically elevated levels.
Policy Backdrop: The Hawkish Fog of the Warsh Era
The concentrated emergence of this "belly" strategy is closely tied to the policy framework changes following Warsh's appointment as Fed Chair.
On June 18, the Fed kept the target range for the federal funds rate unchanged at 3.50%-3.75%, but the policy signals were distinctly hawkish. The dot plot showed about half of FOMC participants project at least one rate hike in 2026. Warsh did not submit a dot plot and eliminated forward guidance, emphasizing adherence to the 2% inflation target and data dependence. The policy statement removed language hinting at a potential future easing bias and was significantly streamlined.
Concurrently, the Fed substantially raised its inflation forecasts—the Q4 2026 PCE inflation forecast was raised 0.9 percentage points to 3.6%, and core PCE was raised 0.6 points to 3.3%. On the economic front, the Q4 2026 real GDP growth forecast was lowered 0.2 points to 2.2%.
Under this policy framework, market expectations for the Fed's path have experienced sharp swings. Following the June FOMC meeting, expectations for 2026 rate hikes increased by 17 basis points to 39 bps, and the two-year Treasury yield rose 12 bps to 4.19%. However, as subsequent economic data was released and market sentiment recalibrated, hike expectations have since moderated.
Analysis suggests Warsh has demonstrated a determination to reform the Fed, but the hawkish signal from the dot plot may have been overreacted to by markets. Other analysis posits that as supporting factors for the economy are expected to gradually weaken later in the year, the currently overpriced market expectations for hikes are likely to be revised.
Market Data: Economic Resilience Coexists with Inflation Pressure
Recent economic data provides a complex backdrop for this strategy. On inflation, the May core PCE price index rose 3.4% year-over-year, the highest since October 2023; headline PCE rose 4.1% YoY, the highest since April 2023. Inflation pressure primarily stemmed from energy prices—energy-related goods and services prices rose 4% month-over-month. However, the May core CPI rose only 0.2% MoM, below the expected 0.3%, offering the market a slight respite.
On growth, the final estimate for U.S. Q1 real GDP showed an annualized increase of 2.1%, higher than the previously reported 1.6%. May personal consumption expenditures rose 0.7% MoM, above the expected 0.6%, indicating continued strength in consumer spending.
In the labor market, May non-farm payrolls added 172,000 jobs, exceeding expectations for the third consecutive month. The June jobs report is due this Thursday, with market expectations for an addition of about 150,000-200,000 jobs. A senior U.S. economist noted, "The labor market is clearly gathering momentum, but that is precisely what the Fed is most worried about right now."
Notably, attacks on tankers near Oman have reignited market concerns about Middle East tensions. This geopolitical risk serves as a reminder that the sustainability of a U.S.-Iran ceasefire agreement remains a key variable.
Major Institutions' "Belly" Positioning
Market activity over the past week has shown traders moderating their hawkish stance. They now expect the Fed to hike once or twice by mid-next year as the peak of the tightening cycle—whereas previously they had anticipated a series of hikes starting as early as next month.
The appeal of five-year Treasuries was further validated in recent data. As of June 26, the 2-year yield fell to 4.13%, the 5-year to 4.167%, and the 10-year to 4.39%. Compared to two weeks prior, the 2-year yield was 14 bps higher, while the 30-year was 7 bps lower, indicating continued flattening relief on the yield curve.
Pimco: Overweight 2 to 5 Years, Going Against Market Consensus
Pimco, managing $2.3 trillion in assets, is among the most steadfast executors of this strategy. Senior Portfolio Manager Michael Cudzil stated that Pimco is overweight interest rate exposure, holding the front and middle parts of the curve (2 to 5 years).
Cudzil's base case runs counter to market pricing: "We don't think the Fed will hike because economic growth should slow in the second half of the year, which will buy time for the Fed to hold rates steady." This area has become more attractive after recent sell-offs. He added, "If the market prices in rate hikes and starts talking about potential easing, then front-end and back-end yields could well fall below 4% in the second half. Market narratives can change in an instant; it only takes a few data points to trigger some volatility."
Pimco's holdings data corroborates this strategy—Treasury futures in the 2-year and 5-year tenors occupy core positions in several of its fund products.
Insight Investment: The $836 Billion "Balance Point"
Brendan Murphy, Head of North American Fixed Income at Insight Investment, calls the five-year a "great balance point" and a "great inflection point." With $836 billion under management, this assessment carries significant weight.
Capital Group: Mid-Curve Rates Preferred Over Front End
Chitrang Purani, a Portfolio Manager at Capital Group, which manages over $3 trillion, stated clearly: "The front end of the yield curve is more volatile, so I prefer the middle part of the curve." He noted that while year-to-date inflation trajectory and economic resilience support hikes, "looking ahead, the drivers of economic growth remain uneven, and inflation is not yet being driven by demand-side factors."
Natixis: Leaving Room for 2027 Easing
The strategy from John Briggs, Head of U.S. Rates Strategy for North America at Natixis, is more forward-looking. He believes if the Fed hikes in 2026, it will exit those hikes in 2027. Therefore, he prefers choosing "the market to be a little bit easier to give more time to digest potential easing expectations."
Outlook: Seeking Balance Between Hawkish and Dovish Forces
Overall, the five-year U.S. Treasury sits at the intersection of Fed policy and inflation expectations. Recent price action reflects growing market confidence that the energy shock is fading, while also showing that the idea inflation can moderate without significantly worsening growth is gaining acceptance.
One bank expects the Fed to hold rates steady until year-end, favoring a shortening of dollar bond duration to 3-5 years. Another bank also believes market doubts about further hikes have cooled following the inflation data.
PIMCO's Ivascyn anticipates that, considering a gradual de-escalation in Iran tensions and disinflationary pressure from AI, overall inflation will remain contained over the next five years. PIMCO remains overweight 2 to 5-year rate exposure. Cudzil noted, "If the market prices in rate hikes and starts talking about potential easing, then front-end and back-end yields could well fall below 4% in the second half. Market narratives can change in an instant."
In this current cycle of high uncertainty, the "belly" strategy may well be the prudent choice to navigate the fog.
Risk Warning: Not Without Headwinds
Despite the broad consensus on the "belly" strategy, risk factors cannot be ignored.
Hike Risk: If upcoming jobs and inflation data show prices are not slowing, the Fed could begin hiking as early as September. Policy-sensitive two-year Treasuries would bear the brunt of the pressure, while five-years, though relatively more resilient, are not immune. CME data shows overnight index swaps currently price a 45% probability of a 25-bp hike in September.
Geopolitical Risk: The tanker attacks near Oman remind markets that flare-ups in Middle East tensions could impact energy prices and inflation expectations at any time.
Economic Downturn Risk: If rate hike expectations persist and intensify, they could lead to tighter financial conditions, subsequently dampening economic growth. PIMCO's Ivascyn pointed out that if economic growth suffers a shock and rates fall, five-year Treasury investors would benefit from price appreciation—implying the "belly" strategy also holds value as a hedge against economic downturn risks.
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