PIMCO Chief Investment Officer: The magnitude of the Fed's rate cut is not the key, the market is too hasty!

Pacific Investment Management Company (PIMCO)'s Chief Investment Officer Daniel Ivascyn, who manages the world's largest actively managed fixed-income fund, said that the bond market's expectations for a Fed rate cut are too high.

The overnight index swap rates in New York on Tuesday afternoon indicate that traders expect the Fed to cut rates by a total of 115 basis points this year. This implies that out of the remaining three meetings, starting as early as Wednesday's decision, one could see a 50 basis point cut. Over the next 12 months, the market expects a total rate cut of over 240 basis points, a pace of cuts that is very rare outside of a recession.

Ivascyn, who manages the $163 billion PIMCO Income Fund, said in an interview, "We believe the market may be getting ahead of itself in terms of short-term rate cut expectations. There is a risk of inflation picking up pace in the coming months, which could result in the Fed's actual rate cuts being lower than what the market is pricing in."

Ivascyn believes that if inflation picks up again, market expectations will be fragile. He mentioned that he is reducing exposure to the "front end of the yield curve" (1 or 2-year bonds) and instead prefers 5-year bonds.

The yield on the 2-year US Treasury, which is sensitive to policy changes, has dropped from around 5% at the end of April to 3.6%, while the yield on the 5-year bond is around 3.4%.

According to Bloomberg data, the income fund managed by Ivascyn has had an annual return of around 3.7% over the past 5 years, compared to the Bloomberg US Aggregate Total Return Index's return of 0.7%.

Ivascyn mentioned the upcoming Fed decision on early Thursday, where the market expects the first rate cut in 4 years to be announced. Traders have fully priced in a 25 basis point cut and believe there is about a 55% probability of a 50 basis point cut.

Ivascyn called the upcoming rate decision a "standoff" situation, stating that the magnitude of the rate cut is not the key. With the stock market near historic highs and credit spreads "very tight," the market has done a lot of work to ease financial conditions for the Fed. He said this reduces the risk of policy mistakes as the Fed has enough room to adjust the pace of rate cuts.

Ivascyn said, "They may have enough tools to correct even if they make a narrow mistake and get things back on track."

Additionally, Vanguard Group, one of the world's largest asset management companies, has closed out its short USD positions established in July, as it believes the Fed's easing cycle will not be as aggressive as the market expects.

Vanguard Group's head of inter-rate Koutny stated that this is not about whether Fed officials will cut rates by 25 or 50 basis points later. Koutny said, "We've seen a significant increase in short USD positions, but US economic data remains strong. Unless data significantly deteriorates from now, we believe the Fed's rate cuts will be less than what the market expects ”