Why Treasury Yields Remain Stubbornly Low Despite Positive Inflation and Fiscal Data

The U.S. Treasury yield curve has defied conventional expectations in late 2025, with 10-year yields lingering near 4.17% despite a cooling inflation environment and a narrowing fiscal deficit. This apparent paradox-low yields amid positive inflation and fiscal data-demands a closer examination of the interplay between market structure, policy resilience, and evolving investor behavior. By dissecting the dynamics of fiscal policy, tariff-driven revenues, and shifting safe-haven demand, we uncover why Treasury yields remain anchored despite traditionally inflationary or deficit-driven signals.

Fiscal Tightening and Tariff-Driven Revenue: A Dual Tailwind

The U.S. fiscal deficit narrowed to $1.775 trillion in 2025, $90 billion below Congressional Budget Office (CBO) projections, driven by a surge in tariff revenue and reduced outlays according to Bloomberg. Customs duties collected in fiscal year 2025 totaled $195 billion-142% higher than the CBO's baseline-largely due to elevated tariff rates, the highest since 1943. These revenues, combined with fiscal reforms such as the reversal of Biden-era student loan forgiveness, contributed to a broader fiscal tightening. While increased Treasury issuance typically exerts upward pressure on yields, the influx of tariff revenue has offset some of the demand-side pressures, allowing yields to remain subdued.

However, the sustainability of this fiscal tailwind is uncertain. Legal challenges to Trump-era tariffs, including a potential Supreme Court ruling on their validity under the International Emergency Economic Powers Act (IEEPA), could invalidate these revenues, creating volatility in fiscal projections. This uncertainty has prompted a cautious approach from investors, who may be discounting future fiscal risks rather than pricing in a clean path of deficit reduction.

Safe-Haven Demand: Resilience Amid Policy Uncertainty

Despite the Trump administration's aggressive tariff policies- raising the average effective tariff rate to 15.8% by November 2025, with China facing a 37.1% rate-U.S. Treasuries have retained their safe-haven status. This resilience is partly attributable to their unmatched liquidity and depth, which remain unmatched even as global investors diversify into alternative safe-haven assets like German Bunds and Asian sovereign bonds.

Yet, the safe-haven properties of Treasuries have shown signs of strain. The April 2025 tariff announcements disrupted traditional correlations between Treasuries and other safe-haven assets, such as gold and the U.S. dollar. During this period, the VIX index spiked to crisis-level levels while the dollar depreciated- a deviation from historical patterns where the dollar typically strengthens in risk-off environments. This suggests a repositioning by global investors, who may be hedging against both inflationary pressures from tariffs and the potential fiscal fallout from legal challenges.

Monetary Policy and Yield Curve Dynamics

The Federal Reserve's rate-cutting cycle in 2025 has further anchored Treasury yields. Three 25-basis point reductions brought the target interest rate to 3.5%-3.75% by December 2025, reflecting a cooling labor market unemployment rose to 4.6% by November 2025 and easing inflation core PCE dropped to 2.5% in April 2025. The resulting yield curve inversion- 10-year yields at 4.17% versus 2-year yields at 3.46% in early 2026-signals investor expectations of further rate cuts, which inherently suppress long-term yields.

This monetary easing has been amplified by fiscal policy. While higher Treasury issuance typically raises yields, the Fed's accommodative stance has offset these pressures by maintaining a supportive yield environment. The interplay between fiscal tightening and monetary easing has created a unique equilibrium, where yields remain low despite rising debt issuance.

Strategic Implications for Fixed Income and Cross-Asset Positioning

For fixed income investors, the current environment underscores the importance of duration management. While Treasury yields appear anchored, the risk of a sudden repricing looms if legal challenges to tariffs succeed or if inflationary pressures from trade policies resurface. Investors may benefit from a barbell strategy: holding short-duration Treasuries to capitalize on near-term rate cuts while hedging against long-term volatility through inflation-linked securities or alternative safe-haven assets.

Cross-asset positioning also requires recalibration. The weakening correlations between Treasuries and traditional safe-haven assets highlight the need for diversified hedging strategies. Gold has gained value as trade-sensitive sectors like technology and manufacturing face headwinds, suggesting that investors should consider multi-asset allocations to navigate the evolving risk landscape.

Conclusion

The stubbornly low Treasury yields of late 2025 reflect a complex interplay of fiscal tightening, tariff-driven revenues, and evolving safe-haven dynamics. While positive inflation and fiscal data might traditionally drive yields higher, the combination of policy uncertainty, monetary easing, and structural liquidity advantages has created a unique equilibrium. For investors, this environment demands a nuanced approach that balances near-term yield expectations with long-term risks from policy shifts and global market repositioning.