NEW YORK, July 28 (Reuters) - Bond investors said they are heading into this week's Federal Reserve policy meeting cautiously positioned as inflation uncertainty clouds the outlook for interest rates, favoring high-quality assets and avoiding large directional bets.

Most investors expect the Fed to leave benchmark rates unchanged in the 3.50%-3.75% range at the end of a two-day meeting on Wednesday. But a surge in energy prices earlier this month and broader inflation concerns have complicated what only weeks ago appeared to be a straightforward hold.

At 3.5%, U.S. consumer inflation slowed in June, but it remains well above the Fed's 2% target, while ongoing U.S.-Iran tensions, which escalated again this month, threaten another oil-driven rebound in price pressures.

With the policy outlook murky, portfolio managers do not see a compelling case for aggressively extending duration or taking on more credit risk. Duration measures the interest-rate sensitivity of a given bond holding.

Instead, they are emphasizing liquidity and flexibility as they wait for more inflation and employment data that could shed more light on the Fed's next move.

That caution was reflected in JPMorgan's latest Treasury Client Survey, which showed little change in investor positioning from a week earlier, with long, short and neutral positions all remaining near their four-week averages.

"I don't think that this is an environment that calls for meaningful positioning," said Jason Granet, chief investment officer at BNY, who said he preferred smaller position sizes and tight risk management heading into Wednesday's decision. "There's a real chance it could go in either direction."

While Granet still expects rates to move higher over time, trying to monetize that view via a large wager on this week's decision is not prudent, he noted. Two weeks ago, he expected little fanfare from the meeting, but renewed inflation concerns tied mostly to energy price increases have since made the outcome less certain.

After starting the year pricing in two to three rate cuts, markets have swung dramatically in the other direction. U.S. rate futures on Monday priced in a 36% chance of a hike this week, according to the CME's FedWatch, up from 16% a week earlier, while showing 43 basis points of increases by the end of 2026.

"The Fed decision itself is the least interesting part," said Neil Sutherland, head of U.S. fixed income at Schroders. "What matters is whether the bar for the next move has gone up or down."

RATE HIKE CAN'T SOLVE OIL SHOCK

Not all investors believe though that the Fed will ultimately follow the market's lead and raise rates.

Eric Winograd, chief U.S. economist at AllianceBernstein, said his firm does not expect further rate hikes, arguing that recent inflation data - which came in softer than expected - and a stable labor market have reduced the need for additional tightening.

"The last inflation print was benign, the labor market looks stable, and much of the recent inflation is driven by higher energy prices - a classic supply shock that monetary policy can't really address," he said.

Winograd added that the recent surge in Treasury yields was due more to the rise in real or inflation-adjusted yields rather than oil-driven inflation fears, which means investors expect strong economic growth given optimism over AI and capital investment.

That combination - no imminent Fed move, stronger perceived growth, and higher real yields - makes this "a very challenging environment" to set duration and curve risk ahead of the Fed, said Winograd.

HIGHER QUALITY FIXED INCOME

The market shift from pricing in cuts to hikes has left Schroders' Sutherland largely neutral on duration as well, shifting allocations away from corporate credit and into securitized assets, mortgages and some municipal debt, where investors can still build high-quality portfolios yielding 5.5% to 6%.

"Credit spreads are very expensive historically...at nosebleed valuations," he said.

Asset manager Nuveen also remains "neutral" across most portfolios, its head of fixed income strategy Tony Rodriguez said, favoring short- and intermediate-maturity Treasuries over the long end of the curve.

"The Fed's not going to be cutting so...the short to intermediate part of the Treasury curve looks more attractive to us."

Rodriguez said he sees little value in aggressively adding credit risk, adding that corporate spreads in many sectors already reflect an optimistic growth outlook.

But with economic uncertainty lingering and little consensus on the trajectory of U.S. rates, investors said rich valuations in parts of the credit market are highlighting the need for security selection over broad risk-taking.

"There's a huge amount of uncertainty," said Schroders' Sutherland. "You've got to be a lot more discerning where you allocate risk within fixed income."

​