US Bond Yield Decline Impacts Dollar: What It Means for Investors

The recent drop in US bond yields is putting pressure on the dollar. Investors are betting that slowing economic growth will lead the Federal Reserve to lower interest rates, even amid continuing inflation. On Tuesday, the 10-year Treasury yield fell to 4.32%—the lowest since mid-December—down from over 4.8% just last month. This change comes as a series of reports indicate weakening consumer and business confidence.

The dollar has weakened as a result, declining 1.9% this year against major currencies. This shift challenges expectations that Donald Trump’s potential return to the White House would support the dollar. Previously, many thought the inflation driven by Trump’s tariffs and immigration policies would stop the Fed from cutting rates.

According to Lee Hardman, a senior currency analyst at MUFG, “Slowing growth and higher inflation expectations create a negative outlook for the US dollar.” Investors note that dropping real Treasury yields—the returns after adjusting for inflation—have significantly influenced this trend. The yield on 10-year Treasury inflation-protected securities (TIPS) also fell to 1.9%, down from 2.3% last month, marking the lowest level since early December.

Persistent inflation puts the Fed in a tough spot. Normally, rising prices would prompt the Fed to halt rate cuts or consider raising rates. However, slow growth combined with Trump’s pressure on the Fed to cut rates creates conflicting signals. Initially, Trump criticized the Fed for maintaining rates, but later called that decision “the right thing to do.”

JPMorgan analysts recently pointed out the notable drop in US real yields due to the Fed’s lack of action in response to a surge in inflation brought on by tariffs. Short-term inflation expectations are rising as investors adjust to the possible impacts of Trump’s tariffs. Measures of inflation expectations have hit their highest levels since early 2023, with a recent surprise uptick in US inflation to 3% in January. The latest Fed minutes warned of potential “upside risks” for inflation, and consumer expectations for long-term price increases are at their highest since 1995.

Despite these inflationary pressures, many investors predict the Fed will cut rates by another half percentage point by the end of the year. Fund managers note that the market is beginning to view the risks from recent trade wars, immigration policies, and public sector layoffs as less threatening to domestic growth.

As we see a decline in nominal US Treasury yields since mid-January, questions are being raised about the future of US economic exceptionalism. Matthew Morgan, head of fixed income at Jupiter Asset Management, highlights the uncertainty surrounding monetary policy and its potential effects on investment, hiring, and growth.

The future implications are significant. If US growth expectations shift, it could influence risk assets. After achieving record highs, stock prices have recently started to decline. A recent S&P survey also reported a contraction in the US services sector, marking the first decline in over two years. Additionally, UBS analysts suggest that falling real yields combined with persistent inflation reflect a “stagflationary impulse” resulting from tariffs.

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