(This Nov. 4 story has been refiled to correct Clayton Triick's name, in paragraph 17)
By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) - Bond investors are keeping a defensive but neutral stance in managing portfolios ahead of this week's Federal Reserve policy meeting, which is being eclipsed by the too-close-to-call U.S. presidential election.
Investors widely expect the U.S. central bank's policy-setting Federal Open Market Committee to cut its benchmark interest rate by 25 basis points to the 4.50%-4.75% range at the end of its two-day meeting on Thursday, which was delayed one day because of Tuesday's election. The Fed slashed its policy rate by a hefty 50 basis points when it launched its easing cycle in September.
The election has been the focus for bond investors the last few weeks, more so than the Fed meeting. And until a winner is declared, investors are being cautious with their allocations, keeping their powder dry.
Bond investors all year have been extending duration, or buying longer-dated assets, as they braced for Fed easing and possible recession. That remains the popular trade in bonds even after the election.
If rates fall, bond prices will likely increase, and longer-dated notes and bonds have historically outperformed shorter-duration assets like cash and Treasury bills in rate-cutting cycles.
"We have initiated small, long positions on the curve, but overall we're closer to neutral," said Brendan Murphy, head of fixed income, North America, at Insight Investment in Boston, which has assets under management of $838.1 billion.
"What's holding us in being more aggressive with that position is the uncertainty surrounding the election. We're going to wait and see."
Janet Rilling, senior portfolio manager and head of the Plus Fixed Income team at Allspring Global Investments, said her firm has also kept a neutral stance given the Fed's data-dependency, the volatility of U.S. economic numbers, and the election.
"Making a call on the winner, which way Congress is going to go, and positioning for that, doesn't make sense," Rilling said. "We would rather be in a position where we can respond ... so when the election has an outcome, we can evaluate (our positions)."
Over the last few weeks, market participants said there has been some position-squaring among institutional investors in the futures market, suggesting caution, ahead of the election and Fed meeting. Asset managers use long contracts in Treasury futures to fulfill portfolio needs.
Commodity Futures Trading Commission data showed asset managers have reduced net long positions on U.S. 10-year note futures that were at a record high as of Oct 1. Other players in Treasury futures have also reduced extreme long or short bets in the last few weeks.
SEARCHING FOR OPPORTUNITIES
Volatility has surged in anticipation of the election. The MOVE index, a gauge of rates volatility, soared to 135.18 last Thursday, the highest level in more than a year. That reading suggested Treasury yields across most maturities will move by at least 8.5 basis points per day in either direction over the next month. On Friday, it was at 132.6.
Harley Bassman, creator of the MOVE index and managing partner at Simplify Asset Management, said based on his calculations, option prices anticipate an outsized move of 18 basis points in Treasury yields in either direction on Nov. 6 or 7.
National polls show the election is a toss-up between Republican former President Donald Trump and Democratic Vice President Kamala Harris. More recently, online prediction markets, which had been showing a victory for Trump in October, are indicating Harris has gained momentum, narrowing the gap.
The so-called "Trump trade" in the bond market has been evident since last month with the rise in Treasury yields, as investors sold notes and bonds, despite the Fed's rate cut. Trump's economic plan, which includes imposing tariffs on some imported products, is likely to boost inflation and add to the massive U.S. fiscal deficit, according to many economists.
With yields and volatility climbing, hardly anybody is making big moves. For some investors though, the absence of major bets is an opportunity before a winner becomes clear.
Clayton Triick, head of portfolio management, Public Strategies, at Angel Oak Capital Advisors, which oversees $17 billion in assets, said agency mortgage-backed securities look compelling. Those securities consist of pools of home loans and real estate debt, typically carrying higher yields than Treasuries.
Allspring's Rilling also noted that investors could still add duration, or switch to longer-dated assets, especially with the recent back-up in yields, starting incrementally: moving from cash to short-duration assets, and then to intermediate maturities.
"The short-term dynamic may be volatile and that may present opportunities for us to get longer (duration)," Insight's Murphy said.