This year’s top U.S. bond managers agree that Federal Reserve interest-rate cuts are inevitable this year. The main debate they see is how deep the economic pain gets.

In a chaotic start to 2023 that featured the most volatile trading in more than a decade, the Carillon Reams Core Plus Bond Fund and the Columbia Total Return Bond Fund have delivered the best returns among 112 U.S. peers that actively manage at least $1 billion.

The funds have led the pack in recouping some of the staggering losses that they and the rest of the bond world suffered last year as the Fed tightened policy at the fastest clip in decades to tame inflation. Now these managers are assessing the breadth of the fallout from those rate increases, in particular the risk of a credit crunch following a spate of bank failures.

After boosting returns last quarter by anticipating the big shifts in front-end Treasuries, Todd Thompson and his fellow managers of Reams Asset Management’s Carillon Reams Core Plus Bond Fund are positioning for a soft landing as the more likely path for the economy. So, a slowdown but not necessarily a deep recession. It’s a scenario they expect will benefit high-grade corporate debt. For Columbia Threadneedle, however, the outlook is more dire, and they’re betting Treasury yields will revisit the lows seen in August 2022.

“The Fed is being overly aggressive in this cycle as they try and maintain their credibility in managing inflation,” said Jason Callan, who alongside Gene Tannuzzo manages the $2.7 billion Columbia Total Return Bond Fund. “There is more likelihood of a harder landing.” 

The $1.3 billion Carillon Reams Core Plus Bond Fund earned 4.2% this year through April 14, after losing about 12% in 2022, data compiled by Bloomberg show. It edged out the 4% return for the Columbia fund, which plunged 17% last year.

For these funds and much of the rest of the fixed-income world, 2022 marked by far the worst performance of at least the past decade. On a three-year basis, both funds have outpaced roughly three quarters of their peers, data compiled by Bloomberg show.

The year-to-date ranking was based on an analysis of funds in Morningstar Direct’s intermediate-term core and core-plus categories. The average return for the 112 funds was about 3.2% through April 14.

Inflation Focus
Data last week showed headline price pressures cooling, while core inflation remained elevated. Meanwhile, consumers’ inflation expectations for the next year surged, leading traders to bet on at least another quarter-point hike by June, and then rate cuts by year-end.

Two-year yields swung some 20 basis points on two days last week, the latest in a series of whiplash-inducing sessions that have rewarded bond managers who nimbly adjusted the interest-rate risk in their portfolios. 

Active managers now face another critical stretch to prove their mettle at a time when even Treasury bills offer rates around 5%. The challenge is that the central bank may prove less willing to ease to stem a credit crunch should inflation stay stubbornly high, even as Fed staffers see a “mild recession” ahead. The central bank’s preferred inflation measure is still more than double its 2% target.

Reams Asset Management’s Thompson acknowledges the risk that the Fed tightens again after a pivot. 

“That’s definitely part of the calculus for the steps ahead,” he said. 

‘Scramble’ Ahead
But a key for him now is preparing for easier policy as the cumulative effects of the Fed’s tightening work to slow economic activity, while the banking turmoil crimps lending.

“Our thesis in credit is that you want to be on the long side and we do expect the Fed to pivot and ease,” he said. “We think the market scrambles for income once we get into a Fed easing cycle,” fueling demand for corporate debt.

For Callan, slowing headline consumer inflation and weakness in housing have emboldened his view that it pays to own bonds or have duration risk. The Columbia fund has a longer duration than the Bloomberg U.S. Agg, lining it up for outsize returns should yields fall.

He sees potential for a 2.5% 10-year Treasury yield, if not lower, by year-end, from 3.58% now. That result could deliver a return of 7% to 10% on top of the fund’s gain in the first quarter, he said. Among the caveats he cited—sticky inflation that keeps the Fed from cutting. 

“There was a lot of volatility in Q1 and as we are rolling into Q2, there is more confidence in the headwinds of tighter policy, and the data is telling us things are slowing,” he said.

This article was provided by Bloomberg News.