Dollar's Link to US Treasury Yields Weaks as Confidence Erodes

The traditional link between the U.S. dollar and Treasury yields has significantly weakened, hitting its lowest point in three years, as investors begin to reassess the reliability of U.S. assets during times of financial stress. This shift comes amid growing concerns that the Trump administration’s trade policies, particularly its tariff-driven trade war, may push the American economy toward a recession. As a result, the dollar has been falling quickly, with investors pulling capital from U.S. assets, while yields on longer-term government bonds remain close to 17-month highs.

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Ordinarily, rising bond yields boost the dollar by making U.S. assets more attractive to global investors. However, that familiar relationship has broken down. This time, the dollar is weakening even as yields climb, raising questions about whether the dollar still holds its reputation as a safe haven or its central role in the global financial system. The options market also reflects a pessimistic outlook for the greenback, with traders increasingly betting that the currency will continue to lose value.

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Analysts from Danske Bank, including Jens Naervig Pedersen, noted in a research report that the disconnect between the dollar, bond yields, and traditional risk indicators is becoming more pronounced and resembles past periods of financial stress. This breakdown in typical market behavior highlights deeper structural concerns among global investors.

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The Bloomberg Dollar Spot Index posted its largest weekly drop since November 2022 and extended its losses into Monday. According to data from the Depository Trust & Clearing Corp., about two-thirds of options traded last week targeted further dollar weakness against the euro, yen, and Swiss franc.

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This rare dynamic is drawing comparisons to historic episodes. Pedersen pointed out that in over 50 years, there have only been three instances when the dollar dropped more than 2.5% in a week while the yield on the 10-year Treasury rose by at least 25 basis points.

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The two other times were in July 1985—during the Plaza Accord, a coordinated international effort to devalue the dollar—and in May 2009, as the world recovered from the financial crisis. Both periods were followed by sustained declines in the dollar’s value.

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The options market is signaling that traders expect a similar trend now. One key indicator, known as risk reversals, measures the difference in pricing between options to sell the dollar and those to buy it. For the first time since early 2020, these risk reversals suggest traders are consistently betting on a weaker dollar across all timeframes—from the short term to a year out.

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Alvaro Vivanco, head of strategy at TJM FX, explained that there’s been a noticeable shift in how investors view U.S. assets. Although there hasn’t been a full-blown panic, there’s clearly pressure on Treasuries and a change in how their movements relate to the dollar. “Selling away from U.S. assets without outright panic may be the dominant trend over the next few weeks or even months,” he said.

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This ongoing shift has pushed the correlation between the dollar and Treasury yields to its weakest level since early 2022, shortly after Russia invaded Ukraine. Back then, safe-haven demand lifted the dollar even though it decoupled from moves in the Treasury market. Now, the situation is reversed: the dollar is losing its haven appeal, and its divergence from rising bond yields is a clear sign that global investors are backing away from U.S. holdings.

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Some experts believe this shift reflects broader doubts about the long-term sustainability of the U.S. dollar as the world’s reserve currency. According to Alberto Gallo, chief investment officer at Andromeda Capital Management, “The sustainability of the greenback as a reserve currency is slowly being questioned.” He added that America’s global reputation is taking a hit, especially in terms of its ability to attract investors to longer-dated debt instruments.

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This erosion of confidence isn’t happening in isolation. The geopolitical climate, the trade war’s potential fallout, and the U.S.'s internal economic and political challenges are combining to make the dollar less attractive. As foreign investors increasingly step back from U.S. markets, even the rising returns on Treasury bonds may not be enough to reverse the downward pressure on the dollar.

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In summary, the dollar’s decoupling from Treasury yields underscores a broader, potentially more troubling development: global investors are reassessing America’s role as a financial safe haven. With options markets signaling sustained weakness and correlations breaking down, the currency’s future dominance is looking more uncertain than it has in years.

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