Dollar-Treasury Yield Correlation Breaks Down

Trump's Policy Volatility and Damage to Monetary Policy Independence
Weakened Preference for U.S. Assets
Correlation Between U.S. Treasury Yields and the Dollar
Falls to Lowest Level in Three Years

The Financial Times (FT) reported on June 1 (local time) that the close correlation between U.S. Treasury yields and the value of the dollar has recently weakened. This is due to investors' concerns over President Donald Trump's inconsistent policies, which have diminished the preference for U.S. assets.

According to FT, after President Trump announced so-called "Liberation Day" reciprocal tariffs in early April, the 10-year U.S. Treasury yield rose from 4.16% to 4.24%, while the value of the dollar fell by 4.7% against major currencies. Since the beginning of this month, the correlation between U.S. Treasury yields and the dollar has dropped to its lowest level in the past three years. This means that the dollar and U.S. Treasury yields, which had previously moved in the same direction, are now moving in opposite directions. Typically, when U.S. Treasury yields rise and the returns on U.S. assets increase, investors buy more U.S. assets in anticipation of higher returns. This process usually increases demand for the dollar, leading to dollar strength. However, this relationship has recently broken down.

Shahab Jalinoos, head of G10 FX strategy at UBS, explained, "If the rise in U.S. Treasury yields is due to increased risk in U.S. Treasuries stemming from fiscal concerns and policy uncertainty, then a weaker dollar can occur at the same time. This is a pattern more commonly observed in emerging markets."

This is attributed to President Trump's large-scale tax cut plan. FT analyzed that President Trump's push for the "One Big Beautiful Bill Act" and the recent downgrade of the U.S. credit rating by Moody's have prompted investors to refocus on the sustainability of the U.S. fiscal deficit, putting downward pressure on bond prices. In the bond market, yields and bond prices typically move in opposite directions. That is, when bond prices fall, yields (returns) rise, and when prices rise, yields fall.

In addition, President Trump heightened market anxiety by attacking Jerome Powell, the Federal Reserve Chair. This week, he summoned Powell to the White House and criticized him, saying that not lowering the benchmark interest rate was a mistake.

Michael de Pass, global head of rates at Citadel Securities, stated, "The strength of the dollar stems from institutional trust. The rule of law, central bank independence, and predictable policies are key to making the dollar the world's reserve currency." He added, "However, the past three months have cast doubt on this institutional trust." He continued, "The market's greatest concern is whether the institutional trust in the dollar is gradually eroding."

The divergence between U.S. Treasury yields and the dollar is a marked departure from the trend of recent years. Until now, expectations regarding monetary policy direction and economic growth have been the main factors influencing the U.S. government's borrowing costs (Treasury yields). However, as the movements of the dollar and other assets have shifted recently, confusion is growing among investors who have relied on the dollar as a 'safety net' in their portfolios.

Andreas Koenig, global head of FX at Amundi, said, "This change alters everything. In recent years, including the dollar in a portfolio was very effective for risk diversification, but now, if the dollar starts moving in the same direction as other assets, the risk actually increases."

Goldman Sachs analysts noted in a recent report, "Concerns over the erosion of the Fed's independence and uncertainty about fiscal sustainability are causing a clear shift in the patterns of asset movements." They pointed out that the recent phenomenon of a weaker dollar occurring simultaneously with rising U.S. Treasury yields and falling stock prices reveals that the commonly used 'hedge' strategy in typical portfolios is no longer effective.

FT reported that one of the reasons for the dollar's weakness is that investors holding dollar assets are actively hedging against uncertainty. As more investors bet on a decline in the dollar (short-selling), this is leading to a further drop in the dollar's value.

Shahab Jalinoos, head of FX, predicted, "The greater the policy uncertainty, the more investors will want to hedge, and this could further amplify the selling pressure on the dollar."

Goldman Sachs recommended that investors consider positions in currencies that have recently shown strength, such as the euro, yen, and Swiss franc, to prepare for dollar weakness. Additionally, the firm noted that these new risk factors provide a strong justification for allocating assets to gold.