Calamos Fixed Income Suite: Targeting the Sweet Spot for Duration

Matt Freund, CFA, Christian Brobst, and Chuck Carmody, CFA

Summary Points:

• We expect the yield curve to steepen, with two to four Fed cuts bringing short-term rates to about 3.5% by the end of 2025.
• Inflation is likely to remain a thorn in everyone’s side, and the Fed is unlikely to tame inflation to its 2% symmetrical target in 2025.
• As 2025 sets up to be a year for consequential economic and policy changes, we continue to migrate credit quality higher on the whole while selectively identifying higher-yielding opportunities.

In a quarter full of important economic data releases and an active Fed cutting cycle, the most significant event was the conclusion of the 2024 federal election cycle. Trump’s victory and a Republican sweep of both houses of Congress imply major policy changes in 2025. Those repeatedly broadcast during the campaign include slashing federal expenses, cutting taxes, implementing additional tariffs, undertaking mass deportations, and reducing regulatory burdens—especially on energy production. All of these factors could significantly impact economic activity.

How successfully President Trump can implement his agenda will be a critical determinant of the ultimate economic impact. Many bolder proposals are likely opening negotiating positions to frame the administration’s goals. There will be resistance to most of the proposed policies, and many will get bogged down in legal battles. In reality, there are still many unknowns.

At the same time, we expect the Fed to slow the pace of cuts in 2025. The yield curve should continue steepening as policy eases toward the Fed’s presumed neutral rate. We still expect the Fed will lower rates two to four more times, with rates around 3.5% at the end of 2025.

Inflation will likely be a thorn in everyone’s side—the Fed, the administration, and consumers alike. Year-over-year measures are already reaccelerating, and unless an unexpected recession develops, our team sees inflation data releases settling back into readings of ~3%, well above its 2% symmetrical target.

Inflation: Stickier than Anyone Would Like—and on the Rise Again

Past performance is no guarantee of future results. Source: Bianco.

Given our inflation concerns, persistent interest rate volatility, a higher-than-expected terminal Fed funds rate, and the market’s growing unease at the size of persistent US deficits (reflected in a higher term premia), our view is that long-maturity Treasury rates will be stickier at high levels with the yield of the 10-year Treasury closing 2025 in a range of 4.75 – 5.25%. As such, we favor the front end of the curve. Fed cuts could generate positive price returns in short-duration strategies, while the long-end dynamics could result in flat-to-slightly negative price returns on strategies with intermediate-to-longer durations.

The consumer is still partying like it’s 1999, although consumption is far from evenly distributed with high earners driving most of the improvement in retail sales. Given the increasing stress on low-income consumers, we see GDP growth decelerating to trend by year-end. That should lead credit spreads in the investment-grade and high-yield markets modestly wider from the cycle tights. Even so, our team believes that with a starting yield above 7% and fairly sturdy fundamentals, the high-yield market is likely to deliver mid-single-digit positive returns for 2025.

Positioning Implications

Our philosophy is rooted in being adequately compensated for the risks we are taking. Even though credit spreads can trade in tight ranges for years, it is prudent to use expensive markets as a low-cost opportunity to migrate to higher overall credit quality. The team has been actively doing so across strategies for multiple quarters, investing in secured structures when possible. However, we maintain meaningful exposures to acceptable credit risks identified through our research-driven process.

Futures markets are pricing an additional three or four cuts through 2026 with a terminal Fed funds rate of about 3.8%. Given the cyclical risks, geopolitical wildcards, and changing political landscape, we believe it is more likely the Fed will overdeliver on cuts, which has led us to position Calamos Short-Term Bond Fund’s duration longer than its benchmark. Calamos Total Return Bond Fund is short its benchmark duration primarily due to an underweight in the long end of the curve, given our concerns about the budget deficit and inflation. In Calamos High Income Opportunities Fund, where interest-rate sensitivity is a lower-order driver of returns, the fund is short of benchmark duration.