A Swirling Array of Factors Suggest Lower Yields

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R.J. Gallo, CFA Senior Vice President Deputy Chief Investment Officer, Global Fixed Income Group Senior Portfolio Manager Co-Head of Municipal Bond Group Head of Duration Committee

The US economy has recently posted stronger than expected growth, including material upward revisions to Q2 GDP to 3.8% and estimated Q3 growth above 3% based on the Atlanta Fed’s GDPNow tracker. Rising consumer spending has contributed to both figures, despite the fact that job creation has waned to a low level. With the US government now shut down, the flow of government labor market statistics will cease. That said, low levels of job creation have not been accompanied by signs of heavy job losses, painting a picture of a resilient economy supported by favorable wealth effects from record stock prices and rising home values among upper income households. Meanwhile, inflation statistics have edged upward, partly due to the ongoing diffusion of tariff effects into prices. In short, better GDP growth, weak job creation, and inflation rising further above the Fed’s 2% target create a cloudy picture for the bond market.

Amid this uncertainty, the Fed’s September 25 bps cut in target interest rates restarted the stalled easing process that began a year ago but was paused on tariff-driven inflation concerns. Treasury yields declined ahead of the September FOMC meeting but have since retraced modestly higher as FOMC members indicate a preference for a balanced approach between inflation and the weakening labor market. The markets reflect expectations that many more Fed cuts will follow, driving the fed funds target rate to the low 3.0% area over the next year. The Fed policy path and bond market pricing hinge on the performance of job creation versus the lift to inflation. Unfortunately, the Federal government shutdown will delay data on both fronts for an indeterminate time.

Will this shutdown be different?

Government shutdowns historically tend to push US Treasury yields modestly lower. After all, furloughs of more than half of all Federal employees, halted wage payments to all Federal employees, and halted payments to government contractors can depress consumer spending if a shutdown lasts many weeks. In the past, all missed payments were made up once the government reopened, limiting the economic impact. This time, however, the Administration is threatening mass firings of some furloughed Federal workers. That threat sounds like a negotiating tactic. Should layoffs occur amid already slow job creation, the economic effects may intensify and support lower Treasury market yields.

Looking abroad, China continues to experience deflation and moderating economic growth, exporting disinflation to other countries. Elsewhere, emerging market growth has been generally buoyant, despite the effect of higher US tariffs. In Europe, the ECB is approaching the end of its easing, and the eurozone economy appears to be firming. In Japan, the BOJ continues to slow walk its tightening process with heavy focus on US tariff risks.

The Federated Hermes Duration Committee elected to maintain a small lean long, viewing the swirling array of factors above as skewing slightly in the direction of lower yields in the near term.

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

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Consumer Price Index (CPI): A measure of inflation at the retail level.

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