The US dollar – along with its connection to bond yields – has lately provided economists plenty to contemplate. Since January, the US dollar index, which gauges the strength of the American currency relative to six major international currencies, has declined by more than 8%. Last month, it reached its lowest point in three years.
Meanwhile, U.S. bond yields have been climbing, contradicting typical economic trends. Normally, during periods of doubt, investors gravitate towards U.S. Treasury securities, seeing them as secure places for their funds. Consequently, bond yields generally drop when equity markets decline, with the dollar often strengthening accordingly. For example, this phenomenon was evident in both the 2008 financial crisis and the tumultuous year of 2020, where the dollar’s strength rose significantly.
In light of the unorthodox economic strategies implemented by U.S. President Donald Trump, financial markets have started displaying increased volatility. Recently, we’ve seen an uptick in bond yields coupled with a decline in the value of the dollar, indicating that investors might be shifting away from American assets and beginning to doubt the reliability of Treasury securities. Those who recall events in the United Kingdom will find parallels between current occurrences over the last four weeks and the debt crisis triggered under former Premier Liz Truss during 2022. Following her contentious fiscal plan, which led to soaring gilt yields along with a sharp depreciation of sterling, the administration was compelled to reassess their approach.
Elevated bond yields indicate that the U.S. government has to incur higher interest payments on its borrowings, which limits its ability to spend elsewhere. Increased expenses related to servicing this debt come at an inconvenient time since the country is already grappling with a substantial budget deficit. For the fiscal year 2024, this shortfall ballooned to approximately $1.8 trillion—the third-highest federal deficit ever recorded in the United States—equivalent to 6.4% of the nation’s gross domestic product. There’s speculation that a rise in bond prices may have influenced President Trump’s choice to temporarily halt certain “reciprocal” tariffs for a period of three months beginning in early April.
The decline of the dollar follows its rise leading up to last year’s presidential election. At that time, U.S. growth was strong, and following Trump’s victory, many anticipated that he would further stimulate economic progress. Additionally, expectations of an uptick in inflation—spurred by Trump’s pledge to introduce tariffs—also contributed to the strengthening of the dollar. Furthermore, prospects of elevated interest rates along with better yields heightened international investors’ appetite for the currency.
Warning signs for investors
“Markets are growing more anxious regarding the reliability of U.S. policies, which is evident from an increase in the term premium required by investors for holding U.S. Treasury securities, along with the declining value of the U.S. dollar,” said Ranjiv Mann, a senior portfolio manager at AllianzGI, to Euronews.
Specifically, Mann pointed out Trump’s exertion of pressure on Federal Reserve Chairman Jerome Powell as a worrying factor.
“Despite Powell’s term lasting until May 2026 and Trump lacking the constitutional power to dismiss Powell prematurely, the concern remains that the Federal Reserve might grow increasingly entangled with politics over the next few years. This could undermine both the credibility of monetary policies and trust in U.S. financial instruments,” Mann clarified.
Trump has recently renewed his criticism of Powell, commenting at a recent rally: “I know much more than he does about interest rates, believe me.”
Apart from threats to the Federal Reserve, several factors are causing concern among investors—signs pointing towards a potential disintegration of both financial stability and political order within the United States. These include the establishment of the cost-cutting bureau known as DOGE, abrupt reductions in foreign assistance, exits from global agreements, the possibility of loosening financial regulations, and President Trump’s indifference toward seeking congressional consent. Additionally, these issues coincide with predictions of an impending economic downturn. Furthermore, at the beginning of April, lawmakers sanctioned a budget plan aimed at reducing taxes significantly, which is expected to substantially increase the U.S.’ fiscal shortfall throughout the coming ten years.
Although the appetite for American stocks and bonds has decreased, specialists indicate that it remains improbable for the United States to fail in meeting its financial debts.
Dollar supremacy
In 1944, during the Bretton Woods conference, the U.S. dollar solidified its position as the global reserve currency. That historic meeting led not only to the establishment of the International Monetary Fund (IMF) and the World Bank but also resulted in countries deciding to tie their currencies to the dollar instead of directly to gold. Consequently, the American currency has become paramount for worldwide exchanges and is extensively kept in reserves by numerous central banks globally. The privileged status granted to the dollar enhances demand for it, providing significant advantages to the United States through reduced financing expenses and increased valuations of assets denominated in dollars.
“It allows the U.S. to sustain ongoing trade and budget deficits without facing immediate consequences, and shields its economy from the typical limitations imposed by increasing debt levels,” Professor Vasso Ioannidou from Bayes Business School in London explained to Euronews. The dominance of the dollar also implies that American sanctions on other countries can have a notably significant impact.
Bernd Kempa, an economics professor from the University of Münster, suggests that the greenback’s reserve status also provides advantages for American manufacturers.
Imports of capital maintain low U.S. interest rates and stimulate further investments, ultimately enhancing the long-term growth potential of the U.S. economy. Additionally, the use of the U.S. dollar in pricing numerous globally traded goods reduces hedging and foreign exchange expenses for American companies.
Despite this, there are those who think the power of the dollar is eroding American manufacturing capabilities—a perspective shared by President Trump and Vice President JD Vance. A robust U.S. currency makes American goods pricier for international consumers, while making imported items more affordable for domestic purchasers in the United States. This contributes significantly to the substantial trade imbalance the country faces with various countries around the world.
A new era?
As Trump diminishes the value of the dollar, it becomes challenging to identify an alternative that might supplant the greenback as the global reserve currency. The Swiss franc, Chinese yuan, and Japanese yen each possess appealing features; however, none boasts the extensive capital markets and reliability associated with the U.S. dollar.
We’re observing increased enthusiasm from investors towards assets denominated in euros,” stated Valdis Dombrovskis, who oversees the European Union’s economic policies, during a recent International Monetary Fund gathering — as noted by The New York Times. “It’s evident that our stability, predictability, and adherence to the rule of law are emerging as significant advantages.
Following the debt crisis of 2009, the euro has regained trust among investors. Today, the ECB plays a more proactive part in bolstering economies via bond-purchasing initiatives, and the EU demonstrates readiness to support struggling members. Recently, optimism surged when Germany pledged to introduce approximately 1 trillion euros in extra governmental borrowing. This stimulus aims at invigorating the Eurozone economy; concurrently, there’s heightened interest in German bonds—viewed as secure assets—which have seen increased demand. Nonetheless, significant challenges persist: a unified financial market enabling seamless monetary movement across Europe remains unfulfilled, necessitating standardised regulations. Moreover, specific countries with high debts continue to detract from the overall economic appeal of the union.
“A shift away from the dollar is theoretically possible but highly unlikely in the near term,” Vasso Ioannidou explained. “That said, recent policy shifts and the US’s retreat from global leadership are prompting other countries to re-evaluate their exposure. Many are already diversifying to reduce risk. If sustained, this trend could gradually erode the dollar’s dominance.”
The dominance of the dollar does not seem likely to end anytime soon, even though investors are starting to pull away. The near-term future of the US currency will largely hinge on decisions made by President Trump in the upcoming months and whether he reverses some of his more disruptive policies.
