The Fed shifts focus

Post Jackson Hole 2025, the bond market appears more confident about the near-term direction in monetary policy with apparent affirmation from Fed Chair Jay Powell. Short and intermediate US Treasury yields trended down over August, reflecting the perception that economic and employment growth have slowed, tariff driven inflation can be tolerated and the Fed will ease toward a soft landing. It may be more complicated than that, but it seems some clarity has emerged recently.

Growth, the budget and tariffs

The US economy has continued to grow at a diminished rate, with real final sales to domestic purchasers (FSDP) expanding at subpar rates of 1.5% and 1.6% over the last two quarters. Tariff increases, economic policy uncertainty and somewhat restrictive interest rates weighed upon economic decisions at households and firms this year. Lately, labor market performance has deteriorated with job creation slowing and the time required for unemployed workers to find a job rising.

The enactment of the One Big Beautiful Bill Act (OBBBA) resolved some of the policy uncertainty and is likely to produce modest near-term economic stimulus from the permanent extension of tax rates, moderate new tax cuts and investment-related expensing provisions. Tariffs, however, will remain a headwind to growth given the roughly 9x increase in the weighted average tariff rate this year to an estimated 16%-20%.

Spiking tariffs are generating hundreds of millions of dollars in flows to the US Treasury that the Congressional Budget Office projects will more than offset the deficit increase from the OBBBA over the next ten years. But that tariff revenue is not free. It falls on a mix of US consumers (in the form of higher prices), US companies (in the form of narrower profit margins) or foreign exporters (in the form of lower net prices on exports). The greater the burden of tariffs falls on the domestic side, the more they will be a detriment to US growth.

Central banks face divergent conditions

Chair Powell shifted focus at Jackson Hole, emphasizing the weakening labor market, suggesting tariff inflation effects should be short-lived, and opening the door to Fed easing. Risk assets warmly greeted the Chair’s tone, with corporate bond spreads tightening and stock prices rising. Perhaps political pressure on the Fed may be seeping into policymakers’ thinking. Though President Trump has backed away from firing Chair Powell, he has attempted to fire another Fed Governor to potentially create a more dovish Federal Open Market Committee.

Looking abroad, the ECB easing path may be nearing its trough with its key interest rate paused since June at 2.15%. The BOJ continues to slow walk any tightening amid building inflation pressures. In Emerging Markets, China and other major economies have posted weaker economic performance—a global trend with local idiosyncrasies.

Current yields

The weighted average yield on the Bloomberg US Treasury index declined over 20 bps during August, driven by declines in benchmark 2- and 3-year yields of over 30 bps while the 30-year yield is unchanged. The Fed’s shift toward easing while inflation remains well above 2% and concerns about Fed independence together have driven steepening of the Treasury yield curve.

The Federated Hermes Duration committee remains vigilant while maintaining its modest lean long position. Amid a likelihood of further curve steepening, our expectation is that the index yield edges lower as easier Fed policy expectations depress short and intermediate yields more than rising risk premia lift long-term yields. Of course, the upcoming employment report always retains the potential for surprise and could cause us to reassess.

Read more about our current views and positioning at Fixed Income Perspectives