Not all cuts are created equal: Rethinking duration in an easing cycle

Key Takeaways:

• A Federal Reserve rate cutting cycle under a resilient macroeconomic backdrop may be unfavorable for long-duration exposures.
• Short-term credit can offer attractive yields with lower interest rate sensitivity.
• Easier monetary policy in a growing economy can support risk assets, with AI-driven investments and financials benefiting from AI build-out, deregulation, and productivity gains.

The Fed seems likely to embark on the next leg of monetary policy easing which may result in investors defaulting to the familiar playbook of buying duration, anticipating lower rates, and looking for capital appreciation in bonds. But investors would be wise to remember that not all cuts are created equal, and easing can have paradoxical effects as you move out the Treasury curve.

Despite some further signs of labor market deceleration recently, the macro backdrop overall has remained resilient with little evidence of job destruction, stable wage growth, and continued strong business investment (especially in AI). Importantly, we believe that business surveys which tend to be a leading indicator of activity, such as ISM Manufacturing or Services new orders, have pointed to an improving growth picture in Q3, reinforcing our optimism despite softer employment data.¹

Inflation has eased, particularly in shelter, which makes up nearly 40% of core CPI, but services inflation excluding shelter has remained well above target.² On top of this, the impact of tariffs appears somewhat delayed relative to our initial expectations, in part, due to inventory accumulated prior to tariff implementation and exacerbated by legal uncertainty contributing to more measured pricing actions on the part of corporates.³ We believe this has resulted in a flatter, but potentially longer-lived inflationary impulse on imported goods which may persist into next year. In short, despite meaningful progress over the past couple years, inflation remains sticky at levels above the Fed’s target, which may limit the scope for a deep or prolonged cutting cycle.

While some further easing may be justified, the six cuts priced between now and the end of next year may prove optimistic, in our view. We believe a more plausible path is one cut in September, one in December, and less easing in 2026 if growth reaccelerates and inflation remains sticky. Of course, one of the key wild cards for next year is the evolving make-up of the Fed Board of Governors (including a new Fed Chair who we expect will have a stronger easing bias). However, as things stand today, without clearer signs of job destruction, this does not look like the kind of cutting cycle that fuels a sustained rally in long-duration assets in our view. Moreover, if the Fed insists on easing into a strengthening economy, we believe “bond vigilantes”⁴ may push longer-dated Treasury yields higher, betting that easier policy in a firming economy will lead to stickier inflation.

Portfolio Positioning

Careful with overpriced duration

If our base case plays out, the traditional approach of loading up on longer duration, fixed-rate assets may underperform again in this cutting cycle similar to the experience we saw last year. Recall, after three weaker months of job growth over the summer of 2024, the Fed initiated an easing cycle in September with a 50 basis point cut, followed by 25 basis point cuts in November and December. However, the economy proved more resilient than feared and inflation remained above mandate-consistent levels. Thus, the 10-year Treasury hit its bottom of 3.61% two days before the Fed's September cut, only to finish the year nearly 100 basis points higher.⁵

Asset class returns since the Fed began to cut rates in September 2024 (9/19/24-8/29/25)

Given the current market setup and aforementioned risks, we are leaning into the following positioning themes:

• Avoid long-end duration: There are two plausible ways we see the long-end lagging over the next few quarters.
  1) The Fed delivers fewer cuts than what is priced, or
  
  2) The Fed delivers the cuts currently priced-in, but the market perceives them as excessive (given reaccelerating growth and still too high inflation in 2026, for example) causing longer-dated (10+ years) yields to sell off. In addition, we view persistent fiscal deficits as an underappreciated risk factor that could limit the upside for long duration.

• Favor short-term credit: High quality CLOs and the front end of the investment grade corporate bond curve (1-10 years) offer attractive yields with relatively low interest rate sensitivity, insulating our portfolios from a sell-off in longer-dated bonds. Additionally, U.S. bank loans continue to out-yield high yield bonds, offering compelling income relative to their volatility profile.⁶

We believe this approach balances the “bird in the hand” of income today with resilience if easing proves shallower than markets expect and long duration bonds become more volatile.

Equities

Easier monetary policy in a growing economy has historically been bullish for risk assets.⁷ After a weak start to the year, earnings revisions turned positive in June and fiscal support is in the pipeline via the One Big Beautiful Bill. Finally, secular AI-driven investment has continued to build momentum with further capex upgrades announced throughout the Q2 reporting season. Thus, we are leaning into themes with room to run:

• We see greater earnings visibility in themes tied to AI build-out, reflected in portfolios by tilting towards the technology sector and exposures tied directly to AI infrastructure.
• We also continue to like financials given the de-regulatory emphasis of the current U.S. administration, a steeper yield curve environment, and the potential for cost savings and productivity gains through AI adoption.

U.S. Census Bureau AI Adoption Survey, % of companies planning to use AI in next 6 mo. by sector

Final Thought: Cut vs. Collapse

A Fed cut is not an automatic tailwind for duration, in our view. In this cycle, the rationale matters more than the rate. We believe cuts amid economic strength, not contraction, call for a strategy that prioritizes income, avoids overpaying for duration, and stays anchored in fundamentals.

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