After “decoupling” from US bond yields, will the US dollar repeat the script of “continuing to weaken”?

The Zhitong Finance App learned that since Trump's tariffs may cause the US economy to fall into recession, investors have withdrawn their US assets one after another, causing the US dollar to fall rapidly. Meanwhile, US long-term bond yields are still close to 17-month highs. Generally, higher bond yields are beneficial to the dollar. But this time, as more investors question the dollar's safe-haven status and central role in the global financial system, the traditional level of positive correlation between the two is the weakest in three years. Options positions show that traders expect the dollar to fall further.

Bank of Denmark A/S analysts, including Jens Naervig Pedersen, wrote in a report: “The confusion between the dollar, yield, and traditional risk indicators is shocking and increasingly reminiscent of past stressful events.”

The Bloomberg Dollar Spot Index recorded its biggest decline since November 2022 last week, and continued its decline on Monday. According to data from Depository Trust & Clearing Corp., about two-thirds of options transactions in the past week were betting on the weakening of the US dollar against the euro, yen and the Swiss franc.

Last week was the third time in more than 50 years that the dollar fell by more than 2.5%, but 10-year US Treasury yields rose by at least 25 basis points, Pedersen said. The other two were in July 1985 — during the implementation of the Plaza Accord to devalue the dollar, and May 2009. The US dollar “continued to weaken” after these two events, he said.

The options market shows that traders are preparing for this situation. The so-called risk reversal strategy is a barometer of investor sentiment. It measures the premium of selling US dollar options compared to buying US dollar options. Risk reversal strategy data shows that from next week to next year, traders are betting on the weakening of the US dollar over multiple time spans. This is the first time since early 2020 that risk reversal strategies at all stages have shown this trend.

Alvaro Vivanco, head of strategy at TJM FX, said: “Over the past week, many people have been watching the pressure on US Treasury bonds and the shift in correlation with the US dollar. Selling off US assets without ongoing panic may be the right framework for the next few weeks to months.”

The correlation between the US dollar and yield was at its lowest level since the Russian-Ukrainian war broke out. At that time, safe-haven funds flowed into the US dollar, even though the dollar was decoupled from the trend of US treasury bonds. Today, the opposite is true: the dollar is no longer benefiting from its safe-haven status, and this chaos reflects an accelerated outflow of US assets.

Alberto Gallo, head of the chief investment office at Andromeda Capital Management, said: “The sustainability of the dollar as a reserve currency is gradually being questioned. This harms America's credibility, and also harms investors' ability to hold stocks for a long time.”