With markets once again anticipating potential Fed rate cuts, it’s an opportune time to revisit how bond portfolios respond to changes in interest rates — and why traditional duration measures don’t always tell the full story. Duration is often used as shorthand for interest-rate sensitivity, but that simplification relies on assumptions that don’t always hold true in practice. One of the most important assumptions is the idea of a parallel shift in the yield curve — where all points along the curve move by the same amount.
The common rule of thumb is: Multiplying a bond’s duration by a change in yield gives an estimate of its price change. For example, a bond with a duration of five years would be expected to rise 5% if yields fall by 100 basis points (or 1%). But that math only holds if the entire yield curve moves in lockstep, which often isn’t the case.
Figure 1: Parallel Yield Curve Shift
For Illustrative Purposes Only. Source: FactSet, as of 8/31/25. Past performance does not indicate future results.
Why the Curve Doesn’t Always Move in Sync
The front end of the yield curve is highly correlated to the fed funds rate, as shown in Figure 2. Therefore, it would be reasonable to expect rates on the front end of the Treasury curve to fall as the Fed cuts the fed funds target rate. Importantly, yields further out on the curve are less dependent upon Fed policy and are more responsive to factors such as inflation, growth expectations and supply/demand dynamics.
Figure 2: Fed Funds Rate and 2-Year U.S. Treasury Are Highly Correlated
Source: FactSet, as of 8/31/2025. For illustrative purposes only. Past performance does not indicate future results.
In practice, the yield curve tends to change shape — that is to say, rates along the curve change in varying degrees. For example, when the Fed cuts rates on the front end, yields further out on the curve may decline to a lesser extent than they do on the front end. In fact, in late 2024, when the Fed last cut rates, the 10-year Treasury yield actually increased by 100 bps.
Figure 3: Non-Parallel Shift of the Yield Curve (Hypothetical)
The information shown is hypothetical in nature and for Illustrative Purposes Only. It does not represent actual investment results, and is not a guarantee of future performance. Source: FactSet, as of 8/31/25.
Key Rate Duration Explained
This brings us back to how rate cuts truly impact bond portfolios. While duration is a useful tool, it can be a blunt one. It assumes small changes in interest rates and parallel shifts in the yield curve. Knowing that the last time the Fed cut rates, the yield curve made a non-parallel shift, investors may want a better understanding of their bond portfolios’ rate sensitivities.
This is where key rate duration comes in. Key rate duration takes duration a step further and breaks down a portfolio by its cash flows in order to determine rate sensitivity at different points (or key rates) on the yield curve. Remember, a bond price is the present value of its cash flows, so the size and timing of those cash flows matters when yields change.
For example, a portfolio of bonds with five-year maturities and a duration of 3.0 may not be impacted if the 10-year Treasury falls by 50 bps (and all other rates remain unchanged). The bonds don’t have a 10-year cash flow. On the other hand, this same portfolio may be more sensitive to changes in the five-year Treasury yield than the two-year Treasury because most of the portfolio’s cash flows occur in five years — with the principal payments at maturity. Key rate duration allows investors to more precisely analyze a portfolio’s rate sensitivity by deconstructing a portfolio duration into its components — the duration at each point along the yield curve.
The Bloomberg Aggregate Bond Index has a duration of approximately six years. Back-of-the-envelope math says that if the Fed cuts rates by 50 bps, the index will appreciate 3% right away because of increased bond prices. However, if the longer end of the curve does not move in tandem with the shorter end, bond price appreciation could be more muted. As shown below in the key rate duration chart, the Agg Index has significantly more sensitivity to the 10- and 20-year rates than the two-year. In late 2024, the Fed cut rates by 100 bps, and the Agg Index was actually down 1.8% (8/30/2024 to 12/31/2024) because the shape of the yield curve changed — front end rates fell while the 10-year rate increased.
Figure 4: Key Rate Duration Provides Better Insight into a Portfolio's Rate Sensitivity
Source: FactSet. Key Rate Durations for Bloomberg Aggregate Bond Index as of 8/31/25. This chart is for illustrative purposes only and does not represent a recommendation of any specific investment strategy. Index data is unmanaged and It is not possible to invest directly in an index. Past performance does not indicate future results.
The Takeaway: Know Where Duration Lives
By better understanding the composition of portfolios and how to apply duration calculations, investors can make more informed decisions regarding positioning for rate cuts. The idea that ‘longer duration means better performance when the Fed cuts rates' is overly simplistic. It ignores the fact that not all parts of the yield curve move together — and that the front end is most directly affected by Fed policy. By looking beyond headline duration and considering a portfolio’s key rate exposures, investors may gain additional perspective on the likely impact of future rate changes.
Definitions:
The Bloomberg U.S. Aggregate Bond Index is an unmanaged market value-weighted index for U.S. dollar-denominated, investment-grade, fixed-rate debt issues, including government, corporate, asset-backed and mortgage-backed securities with maturities of at least one year.
Duration measures how long it takes, in years, for an investor to be repaid the bond’s price by the bond’s total cash flows. Duration is a measure of sensitivity of a bond's or fixed-income portfolio's price to changes in interest rates.
About Risk
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Investing in below-investment-grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. High yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher-quality debt securities. These securities can also be subject to greater price volatility.
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