In the era where the new Federal Reserve Chair, Wash, has fully abandoned forward guidance and the market has entered a new 'data-dependent' paradigm, the world's largest active bond manager, Pacific Investment Management Company (PIMCO), has provided a clear allocation direction: 5 to 10-year US Treasury bonds.
Andrew Balls, Head of Global Fixed Income at PIMCO, overseeing approximately $2.3 trillion in assets, recently stated in an interview that among the various maturities on the US Treasury yield curve, the 'belly of the curve'—specifically 5 to 10-year bonds—is best positioned to withstand the volatility stemming from the Fed's shift towards 'reduced forward guidance'.
Balls anticipates increased turbulence in the US bond market as Chair Wash gradually dismantles the Fed's previous system of forward guidance used to signal interest rate directions. Concurrently, oil price fluctuations and trade tensions are making economic data more volatile. He believes short-term Treasuries will bear the initial brunt of this volatility, while slightly longer-dated bonds are more attractive at current yield levels, particularly when considering inflation-adjusted 'real' yields.
"I think the 5-to-10-year part of the curve looks pretty good," Balls said. "Over the long term, yield is an effective indicator of return, and both nominal and real yields on US Treasuries are highly attractive at present."
Wash's "Farewell to Forward Guidance" Ushers in a Data-Driven Era
Upon taking office, Chair Wash swiftly implemented policy framework reforms. On July 1st, at the European Central Bank's annual central banking forum in Sintra, Portugal, he explicitly announced that the Fed would no longer provide interest rate forward guidance, instead relying entirely on the latest economic data for meeting-by-meeting decisions. He emphasized that forward guidance "is not the right policy tool for the current economic circumstances."
At the June FOMC meeting, Wash even declined to submit his personal interest rate forecast (the dot plot), remarking that "dot plots are drawn in pencil and can be erased." This shift has sparked widespread concern on Wall Street. Investors worry that abandoning forward guidance will force them to rely more heavily on economic data to decipher the Fed's policy path, potentially leading to significantly wider swings in US Treasury yields.
Balls acknowledges this could indeed introduce more uncertainty but adopts a pragmatic stance: "I think it's a bit like the weather; there's no point complaining, you just have to adapt. From my perspective, it's entirely reasonable not to provide much forward guidance in the current environment. Look at what's happened in the last week or two—why provide a lot of forward guidance in such an uncertain environment?"
Inflation Data Cools Sharply, July Rate Hike Probability Plummets
Balls's baseline view is that the Fed will keep interest rates unchanged this year, though he expects the central bank to act if necessary. This view gained strong support following the release of the US June inflation data on Tuesday. The data showed the US Consumer Price Index (CPI) rose 3.5% year-over-year, below the market expectation of 3.8% and down notably from the previous 4.2%. Month-over-month, it fell 0.4%, marking the first monthly decline since 2020. Core CPI increased 2.6% year-over-year, also below the expected 2.8%.
This better-than-expected inflation data tempered market expectations for a Fed rate hike. The implied probability of a July hike shown by interest rate swap markets plunged from about 46% to approximately 20%. The CME Group's FedWatch Tool indicates a significantly increased probability that the Fed will hold rates steady in July.
Wash's Congressional Testimony: 'Zero Tolerance' for High Inflation but Refusal to Pre-Announce Policy
Despite the unexpectedly cool inflation data, Chair Wash sent hawkish signals during his semi-annual monetary policy testimony before Congress on July 14th and 15th. In his prepared remarks, he pledged 'zero tolerance' for the persistent high inflation of the past five years, emphasizing that the Federal Open Market Committee "will not tolerate inflation remaining elevated for an extended period."
Wash downplayed the importance of a single month's data, stating bluntly, "Some people see this morning's data and declare mission accomplished, everything is fine. I absolutely do not subscribe to that view." He continued his consistent communication strategy by refusing to reveal in advance whether the July meeting would result in a rate hike or a hold.
This 'silent strategy' is also drawing increasing criticism. Michael Feroli, Chief US Economist at JPMorgan Chase, warned that if Wash continues to remain silent, he risks ceding the Fed's communication leadership to other policymakers.
Focus on the UK Market: No Gilt Sale Even if Miliband Becomes Chancellor
Beyond US Treasuries, Balls is also closely watching the UK government bond (gilt) market. UK politics is on the verge of a power transition, with Andy Burnham expected to formally succeed Starmer as Prime Minister on July 20th. The market is keenly focused on his choice for Chancellor of the Exchequer.
Energy Secretary Ed Miliband was once considered the frontrunner, but recent reports suggest Home Secretary Shabana Mahmood may have overtaken him. Some market participants worry that a Miliband chancellorship could signal a policy shift from fiscal restraint towards more active government spending. Previously, asset manager Rathbones sold UK gilts due to concerns the Burnham government might "repeat the Truss mistake."
However, Balls indicated he would not sell UK gilts even if Miliband were appointed Chancellor. "Assessing a Chancellor involves multiple factors: economic policy, governing competence, familiarity with the system, the strength to lead the Treasury, and market perception," Balls said. "On those core dimensions, I think he scores very highly on at least two."
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