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The close relationship between US government bond yields and the dollar collapsed as investors cooled American assets in response to President Donald Trump’s volatile policymaking.
Government borrowing costs and currency values ​​have tended to take a step forward from each other in recent years, with higher yields usually showing strong economies and attracting influx of foreign capital.
However, since Trump’s “liberation day” tariffs were announced in early April, yields have risen from 4.16% to 4.42% over the 10-year period, with the dollar down 4.7% against the basket of currencies. This month, the correlation between the two fell to its lowest level in nearly three years.
“In normal circumstances (higher yields) are a sign that the US economy is working strongly. This is attractive for capital inflows to the US,” said Shahab Jalinoos, head of UBS’s G10 FX strategy.
But “if yields rise due to fiscal concerns and policy uncertainty, US debt is more risky, the dollar could be weakened at the same time,” he said.
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The President’s “big and beautiful” tax bill, along with the recent downgrade of Moody’s US credit rating, has led to a sharper focus on deficit sustainability for investors, focusing on bonds.
An analysis by Apollo Chief Economist Torsten Sløk suggested that the US government’s credit default swap spread (which reflects the cost of protecting loans from defaults) is trading at a similar level as Greece and Italy.
Trump’s attack on Federal Reserve Chairman Jay Powell also surprised the market. The president summoned Powell to the White House this week, telling the central bankers he was making a mistake by not cutting interest rates.
“The strength of the US dollar comes in part from its institutional integrity, namely its rule of law, central bank independence, and predictable policies. These are the components that create the dollar as a reserve currency.”
“I’ve been questioning that for the past three months,” he said, adding, “The big concern for the market now is whether the dollar lacks institutional reliability.”
The difference between the Treasury yield and the dollar represents a significant shift from recent patterns in which expectations regarding monetary policy and direction of economic growth were important factors in government borrowing costs.
According to Andreas Koenig, head of global Forex at Amundi, the new pattern could increase the risk of investors seeking Haven’s assets.
“This changes everything. I’ve been making a dollar longer in my portfolio for the last few years. “If the dollar is a factor of balance, then you have a stable portfolio. If the dollar is suddenly correlated, then the risk increases.”
Investors were questioning whether there had been a fundamental change in correlations between asset classes, Goldman Sachs analysts wrote in a memo on Friday.
“That lies in new concerns.
“The recent phenomenon of dollar weakness has challenged both the hedging of a common portfolio, along with higher yields and lower stock prices,” Goldman analysts added.
The weaker US currencies have partially reduced to holders of dollar-controlled assets seeking to hedge these investments, taking a short position in the dollar in the process.
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“The more policy uncertainty there is, the more likely the investors will be to increase their hedge ratio,” said Jalinoos of UBS.
“If the hedging ratio increases with stocks in existing dollar assets, you’re talking about billions of dollar sales (US dollars),” he added.
Goldman analysts have suggested that investors should compete for weakness in the dollar, particularly against the euro, Yen and the Swiss franc. They added, “These new risks create a strong foundation for the allocation of some to gold.”
Additional Reports by Louis Ashworth
