Active Risk in Fixed Income: A Case for Duration Neutrality

Active fixed income managers have many opportunities to add value. Among the most visible is taking a view on interest rates by extending duration when rates are expected to fall or shortening duration when rates are expected to rise. That approach can be effective when the forecast is correct, but it also assumes interest rates can be predicted with sufficient consistency to justify the additional risk. The evidence that follows suggests otherwise.

It also raises a broader question: if forecasting rates is inherently uncertain, is duration positioning the best place to spend active risk? We believe the answer is no.

Interest Rates Are Notoriously Hard to Predict

Professional economists devote enormous resources to forecasting interest rates, yet consensus estimates have consistently missed year‑end outcomes over the past decade. As shown in the chart below, these estimates have been consistently too high or too low. Moreover:

• Median forecasts landed within 20 bps of the year-end actual just twice in ten years (2018, 2025).
• The median forecast missed the year-end actual by an average of ~64 bps.

And It Isn’t Only Economists — the Market Reprices Its Own View

The difficulty of forecasting rates has been on full display in 2026, as the market rapidly repriced its expectations. Entering the year the market was pricing cuts, futures implied just an 11.2% chance that the Fed Funds target rate would sit at 350–375 bps after the July 29, 2026 meeting. By June 30, that same outcome was priced at 68%, with a further 32% implied probability of a hike to 375–400 bps. In six months, the expected path flipped from easing to holding‑or‑tightening. If markets themselves rapidly revise expectations as new information emerges, consistently positioning portfolios ahead of those revisions becomes inherently difficult.

Historically, Betting on Rates Is Expensive in Both Directions — and the Winning Bet Flips Unpredictably

Illustrated below, short‑ and long‑duration bets move in opposite directions, and the winner alternates with no discernible pattern. Furthermore, the magnitude of excess return of short vs. long duration is significant, highlighting the additional source of risk introduced by making interest rate bets and the potentially costly nature of an incorrect guess.

Starting Yield Has Driven Realized Returns

The starting yield at investment has been an important driver of a core bond portfolio’s return over the following ten years. While the starting yield to worst of 4.73% is observable, the rate path is not. Given our belief that rates cannot be reliably predicted, we believe investors may be wise to avoid making potentially costly duration bets (either long or short). Rather, we believe a duration‑neutral approach enables a manager to spend active risk on more sustainable sources of alpha such as bottom‑up security selection and relative sector positioning.

The evidence is historically consistent: interest rates have proven difficult to forecast for economists and markets alike, and the penalty for a wrong duration call can be both large and unpredictable in its direction. Spending your active risk budget on rate bets means spending it where the odds of repeatable success appear low. By remaining duration neutral, managers can instead direct that risk toward more durable sources of alpha such as bottom‑up security selection and sector positioning.

To get Harbor’s latest analysis of the market environment and top‑of‑mind asset allocation considerations, check out our weekly research presentation – The Current.