The Potential Rate Cut Benefits for Short Duration Bonds

Many investors have been keeping money on the sidelines or utilizing money market funds due to high money market rates. This strategy may prove less effective when the Federal Reserve begins cutting rates, opening up avenues for short duration bond funds. That’s what Julian Potenza, Portfolio Manager at Fidelity Investments, noted during VettaFi’s Fixed Income Symposium on April 18.

“When you think about the current dynamics that occur, it’s not overly shocking that investors are sitting in money funds. But I think the focus of this panel is a very important thing to be talking about at this sort of inflection point. Because that next move, when it comes, will really benefit short term bond funds,” Potenza noted.

Rate Cut Outlook

Looking ahead to rate cuts down the line, Potenza noted his belief that two rate cuts later this year remain an option. While Powell seemed to take June cuts off the table, Potenza observed that the Federal Reserve Chair still seems intent on lowering rates later this year.

“I think deep down, Powell still thinks that the neutral rate is very low. That means the policy is restrictive, and the lag is just going to be long. He’s worried about making a mistake and holding rates here for too long,” Potenza observed.

Doug Longo, head of fixed-income portfolio strategists at Dimensional Fund Advisors, was also present during the panel. Like Potenza, Longo believed the Federal Reserve would take some time before beginning rate cuts. Longo observed that the Federal Funds Futures Market is pricing the first cut to potentially happen during the Federal Reserve’s September meeting.

“Because the Fed is dependent on data, it will depend on what the data is. A lot can change between now and then,” Longo added.

Shirt Term Benefit Possibilities

Considering the current economic environment, Potenza elaborated on the benefits short-term bonds can provide over money market funds. While short-term bonds do carry more interest rate risk, Potenza noted that they can potentially benefit from shifts in the yield curve as the Fed moves towards easing policy. Looking at the drivers of the bond market this year, Potenza observed that short and ultra-short bonds provided investors with good total returns.

“It’s more about stepping out of money funds in an inverted curve environment to capture yield as the Fed environment changes to an easing cycle,” Potenza added.

Investment Options

Potenza highlighted a pair of Fidelity ETFs that can leverage the strength of short-term bonds. One such fund is the Fidelity Low Duration Bond ETF (FLDB). The fund was recently released in February and primarily invests in ultra-short-duration bonds. Touting the fund’s strength, Potenza noted that FLDB utilizes an investment-grade focused portfolio and presents a middle ground between aggressive and conservative portfolio strategies.

As a more traditional option, Potenza highlighted the Fidelity Limited Term Bond ETF (FLTB). The fund primarily invests in investment-grade bonds with a three-year duration. Potenza noted that the fund has proven to be a popular short-term option for advisors.

For more news, information, and analysis, visit the ETF Investing Channel.

Fidelity Investments® is an independent company unaffiliated with VettaFi. There is no form of legal partnership, agency affiliation, or similar relationship between VettaFi and Fidelity Investments. Nor is such a relationship created or implied by the information herein. Fidelity Investments has not been involved with preparing the content supplied by VettaFi. It does not guarantee or assume any responsibility for its content.