U.S. interest rates have normalized as the economy and investors have adjusted to the regime change of rates remaining higher for longer.
We expect that the bond market will start the year with a near-normal upward-sloping yield curve for the first time since its inversion at the end of 2022.
Absent another shock, we can see the benchmark 10-year bond trading within its recent narrow range of 4.0% to 4.2%.
Despite protestations otherwise, the yield on the 10-year is 50 basis points lower than at the start of 2025, when investors were uncertain about the impact of tariffs on inflation.
As we have long noted, long-term interest rates are determined by the $30 trillion U.S. bond market, relative to domestic and international perceptions of U.S. inflation and economic growth.
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A simple rule-of-thumb calculation would say that with expectations of long-run inflation at 2% and with a 2% real rate of return, a bond yield on the order of 4% to 5% seems logical, all relative to nominal GDP growth of 4.5%.
With inflation in 2026 likely to range between 2.5% and 3%, risk of a move to 5% in the long-term bond cannot be discounted. Such a move would not be conducive to a recovery in the anemic housing construction market.
The normality in the bond market has been matched by conditions in the money market, where the Fed has taken steps to maintain consistency among the overnight rates that power commercial enterprise.
And the equity market has bounced off its mid-December slump in an environment of low volatility, such that all three sub-components of our financial conditions index remain slightly positive.
This end-of-year complacency results in the RSM US Financial Conditions Index remaining above zero, indicating an accommodative environment for borrowing and lending with the potential for economic growth.
These financial conditions coincide with a consensus among economists for a moderation of inflation and for real GDP growth of 2% in 2026.
The Fed foamed the runway as hiring slowed in the second half of 2026 to an average of 23,000 per month from July through November.
Yet the blowout 4.3% growth path in the third quarter begs the question of just how much the Fed can do for hiring if the front end of the curve declines compared with the risk around sticky inflation, which will push up rates between 10 and 30 years.
And that is one of the major economic and financial market questions that will be answered in 2026.
