Why hasn’t the rise in US Treasury yields boosted the US dollar exchange rate?

Since September, U.S. Treasury yields have experienced a round of rate hike trades, but interestingly, the U.S. dollar index has remained nearly unchanged. The 2Y U.S. Treasury yield has risen by more than 20bp since the start of the month, market pricing shows an 88% probability of a September rate hike, and two hikes have been fully priced in for the rest of the year. Meanwhile, the U.S. dollar index remains at 99, with almost no fluctuation.

How do we understand this significant divergence between the U.S. dollar and U.S. Treasury yields? I believe there are several points to consider:

First, this round of rising interest rates is global, so the U.S.-non-U.S. interest rate spread has not widened. Historically, when monetary policy diverges between the U.S. and other economies (e.g., in 2022), the logic of “high rates leading to a strong U.S. dollar” is straightforward.

However, this time the rate hike is global. Over the past month, German, UK, and Canadian government bond yields have all risen by more than 30bp. The U.S.-non-U.S. rate differential, as reflected in the dollar index, is centered around 99 and does not appear to be overly high or undervalued.

Will the U.S.-non-U.S. interest rate spread diverge in the future? It probably will, as this wave of global rate hikes has already priced in too many expectations. Eventually, there will be some countries with weaker fundamentals who will be unable to keep raising rates, or perhaps will over-tighten. This is a key medium-term issue, but at the moment, it isn’t the market’s main focus.

Besides the interest rate spread, another reason for this round of flat performance by the U.S. dollar is the pressure from strong Asian currencies. Although the dollar index as a whole hasn’t moved much, if you look closely, there is a very clear intraday pattern—weak during the day, stronger at night.

I believe the dollar’s weakness during Asian trading hours is partly due to the strength of Asian currencies. The top three Asian currencies (CNY, KRW, JPY) each have their own flow logic, such as CNY’s settlement of foreign exchange, share buybacks by listed companies in Korea, etc.

There are also signs that Japanese yen investments overseas are starting to flow back to Japan. While the flows are not large, they are indeed happening, which objectively supports the “soft U.S. Treasuries + soft U.S. dollar” combination. If the trend of Japanese funds returning to Japan continues, the yen could show greater resilience even in the context of high U.S. Treasury yields.

Based on the analysis above, I’ll update my views on FX and asset markets:

FX: Asian currencies (CNY, KRW, JPY) show greater resilience, and may not drop much even if the U.S. raises interest rates. European currencies (EUR, GBP) are more likely to remain volatile, as the U.S.-Europe divergence is not yet obvious;

U.S. Treasuries: The short end of the U.S. Treasury curve has fully priced in rate hike expectations, but the main risk lies in the long end (supply-demand issues, global rate hikes). It’s best to stay observant for now; if the 10Y U.S. Treasury stabilizes at 5.0%, there is some value for left-side allocation;

Gold: Risks in U.S. Treasuries (such as supply and demand issues) indirectly support gold, which is why gold can resist rising Treasury yields. If you’re unsure what to buy, a bit of gold may not be a mistake.

[August U.S. CPI Guessing Contest Results Announced]

Congratulations to the friend who guessed 3.4%. Please leave your shipping info in the background, and the prize will be sent out within five working days.