Historically, there's been a high correlation between U.S. Treasury Yields (10-year bonds) and the value of the U.S. Dollar (USD). The accompanying chart for this research highlight shows the relationship from September 2022 through June 2025. In 2025, there appears a significant deviation, which happens to coincide with "Liberation Day" - the date on which the Trump administration levied tariffs on all its trading partners around the globe. What can we attribute this dramatic breakdown in correlation?
We could view the relationship divergence through the lens of these three specific catalysts:
- Aggressive U.S. Trade Policies and Tariffs
- The Trump administration's imposition of widespread tariffs in early 2025 (e.g., doubling steel/aluminium tariffs to 50%) triggered investor concerns about slower U.S. growth and corporate earnings. This led to capital flight from dollar-denominated assets, as tariffs were cited 107 times in Federal Reserve's Beige Book as a drag on economic activity.
- Historically, tariffs disrupt trade balances and investor confidence. The dollar index (DXY) fell 7.3% from its January 2025 peak amid fears of a recession and retaliatory measures from trading partners like China and the E.U.
- Political Uncertainty and Eroding Confidence in U.S. Institutions
- Threats to Federal Reserve independence (e.g., Trump's public criticism of Chair Powell) undermined investor trust in U.S. monetary stability. The dollar hit a three-year low in April 2025 as markets reacted to this unpredictability.
- Rising fiscal deficits and political polarization further strained confidence. The U.S. current account deficit ($1.1 Trillion annually) relies on foreign capital inflows, which slowed due to policy volatility.
- Shift in Global Investor Sentiment and Diversification
- Foreign investors began reallocating capital away from U.S. assets (stocks and bonds) toward Europe and Japan, where growth prospects improved. Japanese investors were net sellers of U.S. bonds for six consecutive weeks in early 2025.
- The dollar's overvaluation (up to 20% above long-term averages) meant it was already vulnerable to a correction. Even Goldman Sachs and JP Morgan projected further USD declines against the euro and yen, citing cyclical unwinding after a decade of strength.
When demand for U.S. Treasuries decline, as has been the recent sentiment from foreign buyers, prices decline and their yields inversely increase. Similarly, when USD denominated assets are less in demand, there's lower demand for dollars which naturally weakens its value relative to a basket of other global currencies. USD is a market like any other, dependent upon supply and demand dynamics.
The U.S. economy relies greatly on imports (and has run a consistent trade deficit for decades now). Disrupting the global trade to the extent that we've witnessed may have long-lasting impact to the desirability and attractiveness of all U.S. assets. If so, this poses yet another alarming threat to those U.S. investors who exercise more home country bias in their retirement income portfolios.
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