Yields Stay in Tight Range as the FOMC Restarts Interest Rate Cuts

Core bonds finished the quarter with a gain of 2.1%. About half the returns were derived from income and half from price gains. Core bonds had a poor fourth quarter in 2024 and thus the gap between year-to-date returns at 6.2% and 1-year returns of 2.8%. Positive excess returns from corporate bonds and mortgage-backed securities (MBS) continued in the third quarter. Corporate bonds have outperformed Treasurys by 2.3% over the last 12 months. MBS are only slightly better at 0.3%.

The 10-year Treasury yield began the quarter at 4.23% and finished only 8 basis points lower at 4.15%. This marks the second consecutive quarter that yields finished within 10 basis points of where they began the quarter. The spread between the yield on 30-year Treasurys and 5-year Treasurys widened by just 1 basis point in the quarter.

  • The Federal Open Market Committee (FOMC) reduced the Federal Funds rate by 25 basis points at their September meeting.
  • Based on FOMC projections, additional cuts are expected in the fourth quarter.
  • The market is pricing in an additional four cuts over the next 12 months.

Economic data has only become muddier. Tariffs are no longer on the top of the concern list and has been replaced by weakening employment data.

  • The unemployment rate (U-3) of 4.3% has been above the three-year moving average for 16 months.
  • The last seven times the unemployment rate crossed this moving average a recession occurred.
  • Offsetting this are positive overall economic surprises and a nearly 4% GDPNow forecast.

Strategy Positioning

Our strategies are positioned slightly underweight on duration from a secular standpoint. We moved the duration up slightly in anticipation of weaker employment but think this is noise in the bigger picture. Two important things are missing that were present in all seven previous recessions:

  1. Jobless claims spiking 40% from the cycle low and crossing 300,000.
  2. Nominal GDP falling under the Federal Funds rate. Also, in the seven previous recessions the U-3 moving average cross occurred while already in recession or within three months. It has been 16 months, and while recessions are always backdated, it is pushing the extremes on being a valid signal based on historical timing. If one of the requirements above trigger, we would reassess our positioning.

Our strategies are slightly overweight corporate bonds and MBS. The conditions for recession don’t appear to be in place. The latest FOMC press conference was taken as somewhat hawkish by much of the media. Our view is that 125 basis points of cuts (and more to come) with the S&P 500 up 95% over the last three years to be extraordinarily dovish. We think spreads will remain near record highs given this backdrop, although the risk/reward is less than optimal.

The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.

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