Treasury yields reflect a curious equilibrium to start the year

As we begin the new year, actual and implied volatilities in the US Treasury market have fallen to four-year lows, returning to levels that were common before the pandemic. Of course, the last four years included a number of disruptors: the inflation surge to multi-decade highs; the Federal Reserve’s (Fed) rapid tightening to suppress inflation; the Silicon Valley Bank crisis; President Trump’s tariffs announcement; and the eventual Fed easing in response to weakening job creation.

So far, recent events have not matched any on the above list of drivers of economic uncertainty, which is good news. That said, a variety of forces have emerged lately that collectively confine Treasury market yields to a narrow trading range.

Fiscal policy and economic growth

• The federal shutdown halted nearly all government data releases for October and part of November, starving the data-driven Treasury market of key information. 
• The shutdown also halted discretionary government spending for 43 days (think spending on government contracts and salaries for federal workers), thus muting economic activity in Q4 2025 that was then pushed into the current quarter as discretionary spending resumes.
• Job creation has slowed to a crawl, unemployment claims remain muted, and the unemployment rate has risen to a four-year high. The labor market now rests in a curious equilibrium that could resolve by either breaking towards more pronounced weakness or rebounding as the effect of Fed easing, rising capital expenditures, and the One Big Beautiful Bill Act fiscal stimulus support economic growth in 2026.

Monetary policy and financial market conditions

• The Federal Reserve has lowered its target federal funds rate into the wide range perceived as neutral, and the Fed has signaled a near-term intent to step to the sidelines, all while the market awaits President Trump’s nomination of the next—presumably dovish—Fed Chair. 
• The decline of inflation has leveled off, staying stubbornly above the Fed’s 2% target, as tariffs seep through various product and service categories amid continued above-trend US economic growth that could reinforce inflation.
• Financial conditions have become more accommodative with credit spreads historically tight and stock prices at record highs, allowing substantial amounts of AI-related capital-raising. The related financial wealth effect is supporting consumer spending by upper income households, while lower income households struggle amid weak job creation, higher price levels, and elevated mortgage rates.

Trade policy

• The Supreme Court will soon reach a decision regarding the statutory authority invoked by President Trump for his extensive tariffs. This brings the potential to lower or reverse expected federal tariff revenues and could prompt alternative trade policy changes if the Trump Administration loses the case.

Geopolitical concerns

• High profile geopolitical events continue to evolve—from Gaza to Ukraine to Venezuela—but in a manner that markets view as unlikely to change near-term macroeconomic trajectories and insufficient to drive any lasting retreat from risky assets. This is a scenario that could change quickly with another surprising event.

Facing this long list of forces and factors that require more time to evolve, and could cause a range break in either direction, the Federated Hermes Duration Committee currently holds a “neutral”/“at index” duration stance.

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