USD weakens despite rising US bond yields – the sky is falling! Or maybe not...

At Tricio we use charts in order to look for insight into market sentiment and investor behaviour. Sometimes why market prices are moving is crystal clear, other times, not so much! The recent big moves in US bond yields and the USD are a case in point. There has been a lot of financial media and analyst comment on why bond yields have been moving around so much in the US. There has also been a lot of commentary about the weakening USD.

We see the bond moves as reflecting the continued tussle between growth and inflation fears, and we believe that this will be resolved with bond yields falling as growth fears materialise and inflation fears subside. We (cheekily) suggest that the weakening USD shows that the market is finally catching up with our long-held view that the USD gains peaked in 2022 and will be retraced. More USD losses are likely, as we have pointed out in previous blogs, podcasts, webinars, Focus reports, our Weekly Talking Points and Monthly Insight publications.

A bit of history

The weekly US 10-yr. note yield chart (below) shows that bond yields fell hard in early 2020 as the Covid pandemic hit lives and the economy. Yields rose as hopes of vaccines and economic recovery were seen in 2020 and 2021. Yields rose sharply in 2022 and 2023, peaking just above 5% as the US economy surged and inflation readings picked up sharply. The rise in general prices was due to various reasons, but the Russian war on Ukraine did push energy and some food prices up which didn’t help.

Yields dipped to 3.60% in the summer of 2024, with the rising unemployment rate triggering the ‘Sahm rule’ and economic slowdown fears. The Fed started to lower rates in September 2024, but the bond yield had already dropped 140 bp or so in anticipation of the Fed reducing their restrictive stance.

Yields rose to just above 4.8% in mid-January 2025 as markets priced in the potential impact of the new US tariff policy (higher or ‘sticky’ inflation readings) which had been widely advocated by the new administration. Yields fell sharply over the next few weeks though as the actual details of the policy were announced and investors took the view that the risk of a recession had risen, which may dampen the effects of tariffs on inflation readings. The fall in the bond yield from 4.81% to 3.86% though was corrected last week as yields rose sharply to 4.59% again.   

Financial media commentary suggested that the recent bond yield dive to 3.86% was triggered by many technical factors as well as rising recession risk. One potential factor were bond basis trades and swap markets in dislocation forcing bond buying and the unwinding of some trades. Another consideration of course is flight to safety bond buying as equity markets cratered as the announced US tariffs were a lot higher than many expected. Since touching 3.86% though the rise in bond yields has been cited as a potential reason that the US administration backed away from some of their announced tariffs with a 90-day reprieve and a global 10% tariff in place. Except for China, which is around 145% and many metals and autos which have their own regime. These could change very fast of course, as the last few weeks has shown us. While there is a lot of speculation that the odd manner in which US policy has been announced and then changed and then changed again could be knocking investor confidence in US markets, it is probably a lot more likely that the big move in bond yields from 4.81% to 3.86% prompted some adjustments (profit taking) by some bond holders. This saw bond yields back away from overshooting to 3.86% to a more ‘neutral’ area.

China bond buying strike fears are another potential factor for bond yields rising from 3.86%. With the US and China engaged in a tariff war, could China stop buying US bonds or even sell their holdings in a bid to punish the US? Economists generally agree that the US trade deficit with China over the years has seen China put some of their USD’s into US bonds instead of letting the CNY firm sharply. Exchanging paper (money) for goods and having the paper holder fund your bonds (keeping yields supressed) is one way that this argument runs. If there are not that many USD’s flowing into China in the first place (trade war), then China may not need to buy that many bonds – hence the rise in bond yields. A key factor though is that the Chinese holdings of bonds has fallen sharply over the last decade as the chart below from FXStreet shows. So while China bond buying strike fears may cause market worries, it is probably not enough to really crash the bond market.

FX and bond yields

Rising US bonds yields can be supportive of the USD. The weekly chart below shows the spread between the German 10-yr. bund yield and the US 10-yr. note yield (red) and the EUR/USD (black). As the red line falls, US bond yields are rising relative to German yields and the EUR/USD often seems to track lower. As the red line rises, US bond yields are falling relative to German yields and the EUR/USD tracks higher. This is not an absolute relationship and many trading and currency overlay models will use interest rate spreads as part of their modelling, but rarely as the only factor. 

The daily chart below shows what is flummoxing the market at the moment. We had become used to the red and black lines moving in the same direction over the last few years – until they didn’t last week! Rising US bond yields have sent the yield spread (red line) sharply lower. The EUR/USD (black line) though, is up a lot. Is the relationship over? Probably not. We are leaning to the view that the US note yield will probably fall back towards 4% over the coming months. The EUR/USD has retraced the ‘Trump bump’ which had taken the EUR from above $1.12 to below $1.02 over the last few quarters. Expectations of a recession in the Eurozone have been baked into the market for some time. FX traders look ahead though, and the news from Germany that they will be borrowing and spending on infrastructure and defence over the coming years has sparked early recovery hopes, and pushed the EUR/USD higher. This should continue and see the red line bounce a touch (lower US bond yields relative to German yields) and see the EUR/USD work higher over time, to our long-standing $1.20 target.