Treasury Yields Keep Climbing. The Dollar Might Tell Us Why.

(Dreamstime)

Over the past week or so, the 10-year Treasury yield has inched upward to nearly 5%, a critical psychological threshold for investors around the world. Amid the million articles being posted on this rise (this is will be the million-and-first), there is no consensus on its cause.

Some explanations point to relatively benign factors: the continued strength of spending and the continued rise in corporate bond issuance associated with AI investments. Other explanations are more concerning: heavy Treasury issuance to finance federal budget shortfalls, persistent above-target inflation, and mounting uncertainties about future monetary policy. Finally, and most worrisome of all, is the possibility that political paralysis will stymie any correction of fiscal deficits and ultimately engender soaring bond yields, a financial crisis, or even a federal default.

How can we distinguish between these explanations?

One way is to listen to what the dollar is telling us. Higher yields in the U.S. relative to abroad signal a strong economy and profitable rates of return that attract investments from other countries. So, in ordinary circumstances, increases in U.S. bond yields should boost the dollar.

But if yields are going up for the wrong reasons—rising inflation, too much issuance, or worries about future debt sustainability—that would be a “turn off” to investors. It would lead to less dollar appreciation or even dollar depreciation.

Right now, the dollar is telling us that the rise in long-term yields is not a good thing.

I came to that conclusion after analyzing a regression model of daily changes in the log of the DXY dollar index, which measures the dollar’s value against a weighted average of major advanced-economy currencies.

The model considers the difference between U.S. 2-year Treasury and a weighted average of foreign 2-year sovereign bond yields, the difference between the slope of the U.S. yield curve (the 10-year yield minus 2-year yield) and the weighted average of foreign yield curves, and a leading measure of stock market volatility called the VIX .

Traditionally, increases in U.S. yields or in the slope of the yield curve relative to yields abroad attract foreign investments and boost the dollar. Similarly, increases in volatility also attract foreign investments and boost the dollar, since dollar investments are usually considered a haven from disruption and uncertainty.

That isn’t what we are seeing here.

Created with Highcharts 9.0.1Rise in U.S. Yields Vs. Those Abroad Now Comes With​Weaker DollarDaily dollar moves when the slope of the U.S. yield curve rises relative to foreign yield​curves Source: MarketWatch

Created with Highcharts 9.0.1Liberation Day2023'24'25'26-15-10-5051015%

Until early in President Donald Trump’s second term, the sensitivity of the dollar to the difference between the slope in the U.S. yield curve and foreign yield curves was mainly positive, as expected. Increases in U.S. 10-year yields relative to those abroad boost the dollar.

But immediately after “Liberation Day” in April 2025, when Trump shocked the world with his announcement of “reciprocal” tariffs, that sensitivity turned negative and started fluctuating widely around a lower baseline. The change in the dollar’s sensitivity is even more apparent when we compare its average value over the pre-Liberation Day period with that during the post-Liberation Day period.

Increases in 2-year yield differentials still boost the dollar, indicating that investors continue to have confidence in Treasuries and the dollar over the near term.

But the dollar’s sensitivity to the VIX has more than halved, suggesting that investors no longer view the dollar as much of a haven from financial volatility. And, most worryingly, the dollar’s sensitivity to the yield-slope differential has swung from positive to negative. This means that, for given 2-year Treasury yields, a rise in 10-year Treasury yields relative to those abroad now is associated with a lower, not higher, dollar.

This reversal of the dollar’s response to higher long-term Treasury yields doesn’t tell us whether the recent rise in yields reflects expectations of higher inflation, the pressure of rising Treasury issuance, or worries about the sustainability of the federal budget. Nor is it clear whether the factors undermining the attractiveness of Treasuries are due to Trump administration’s policies or trends that have already been in play for some time.

But, either way, when investors view rising compensation as a signal to sell the dollar rather than buy, that isn’t good. And with the Congressional Budget Office projecting the federal debt to rise to 175% of gross domestic product by midcentury, it isn’t going to get any better, absent any major corrective action.

What to do? The answer is obvious, even if politically difficult: Stop trying to staunch the fiscal hemorrhage with Band-Aids like bond buybacks and Japanese yen interventions. And stop hoping that we can just grow our way out of our fiscal problems.

Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.

Steven Kamin is the former director of the Federal Reserve Board’s International Finance Division and a current senior fellow at the American Enterprise Institute.

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