Cracks in Dollar Hegemony: The Collapse of the Correlation Between U.S. Treasury Yields and Dollar

U.S. 10-Year Treasury Yield vs. Dollar Index (Source: IFE Analytics)

Prologue: A Shattered Golden Rule of Financial Markets

For 75 years since the Bretton Woods system, a golden rule has dominated global financial markets: when U.S. Treasury yields rise, the dollar strengthens. Higher yields were seen as a sign of a strong economy, attracting foreign capital and pushing up the dollar. This relationship was considered so solid that traders and investors treated it as nearly a law of physics.

But since April 2025, that rule has broken down (see graph above). After President Donald Trump declared a “Liberation Day" Tariffs, the 10-year Treasury yield rose from 4.16% to 4.42%, but the dollar fell 4.7% against a basket of major currencies. The correlation between the two assets has hit a three-year low. This isn’t a mere market anomaly. It reflects deepening concerns over U.S. policy uncertainty, the independence of the Federal Reserve, and the long-term sustainability of American fiscal policy, shaking the very foundation of the dollar’s reserve currency status.

Anatomy of a Broken Correlation

The Traditional Mechanism

For decades, the link between Treasury yields and the dollar was intuitive:

• Growth Signal: Higher yields reflected inflation pressures and strong economic growth—interpreted as signs of a healthy U.S. economy.

• Interest Rate Arbitrage: Rising yields attracted global capital seeking carry trade opportunities, boosting demand for dollar assets.

• Expectations of Fed Policy: Higher yields anticipated hawkish Fed policy, increasing buying pressure on the dollar.

• Safe Haven Demand: U.S. Treasuries were considered “risk-free,” and higher yields made them even more attractive to foreign investors.

A New Reality: The Rise of Risk Premiums

Today, things are different. High yields no longer reflect economic strength but rising risk. If Treasury yields rise because investors are worried about fiscal deficits or policy instability, the dollar can weaken even as yields increase.

This is a pattern more commonly seen in emerging markets like Brazil or Turkey—where bond yields spike due to fiscal or political turmoil, and currencies simultaneously weaken. Alarmingly, this is now playing out in the world’s largest economy.

The Double Blow of Trump’s Policies

The Shadow of the “Big, Beautiful” Tax Plan

President Trump’s massive tax cut package is promoted as a growth stimulus. But markets view it differently:

• Fiscal Deficit Concerns: The U.S. is already running a deficit worth 6.28% of GDP, raising alarms about sustainability. The tax cuts will likely worsen it.

• Moody’s Downgrade: Moody’s recently downgraded U.S. credit for the first time since 1941—a sign that fiscal credibility is in question.

• Surge in Credit Default Swaps (CDS): According to the Financial Times, U.S. CDS spreads are now trading at levels comparable to Greece and Italy—indicating the market no longer sees the U.S. as a default-proof borrower.

  
  

Attack on Fed Independence

President Trump’s pressure on Fed Chair Jerome Powell further undermines confidence in a key pillar supporting the dollar.

• White House Summons: Trump recently summoned Powell to the White House and pressured him to cut interest rates, eroding trust in the Fed’s autonomy.

• Risk of Political Interference: The dollar’s strength as a reserve currency has relied on institutional integrity—rule of law, central bank independence, and policy predictability. Under Trump’s second term, this trust is fading fast.

Paradigm Shift in Investment Strategy

The Breakdown of Hedging Models

This shift poses major challenges for investors:

• Loss of Dollar as a Stabilizer: Holding long-dollar positions has long served as a stabilizing force in portfolios. But if the dollar starts swinging with other risky assets, it amplifies, rather than reduces, risk.

• Traditional Hedges Under Pressure: The simultaneous dollar decline, bond price drop (i.e., yield rise), and stock weakness erode confidence in classic hedging tools. The market may be running out of safe havens.

  
  

A Surge in Hedging Demand

• Rising Dollar Hedging Ratios: As U.S. policy risk grows, investors are increasingly hedging their dollar assets—translating to billions in dollar selloffs.

• Shift Toward Alternative Currencies: Institutional investors recommend shifting toward the euro, yen, and Swiss franc—all of which have appreciated in recent months.

• Increased Gold Allocations: Goldman analysts note this environment provides a strong case for holding gold within diversified portfolios.

Reordering the Global Financial System

A Multipolar Currency World Emerging

The weakening of dollar hegemony isn’t just a U.S. issue—it reflects a transformation in the global monetary order:

• Rise of the Chinese Yuan: China is expanding yuan-based trade settlements with countries like Russia and Iran. As U.S. unpredictability persists, more nations may seek alternatives to the dollar.

• Opportunity for the ECB: With relatively stable monetary policy, the EU has a chance to expand the euro’s international role.

• The Digital Currency Alternative: The growth of Central Bank Digital Currencies (CBDCs) could offer systemic alternatives to the dollar-based payment network.

  
  

The Emerging Market Dilemma

• The Double-Edged Sword of Dollar Weakness: A weaker dollar usually benefits emerging markets by lowering debt burdens and boosting commodity competitiveness. But if the weakness stems from U.S. dysfunction, it may destabilize global markets.

• More Volatile Capital Flows: As investors search for new definitions of safety, capital movement across borders is likely to become more volatile.

Central Banks Responding to the Shift

The Fed’s Dilemma

• Balancing Political Pressure and Policy Independence: The Fed must walk a tightrope between Trump’s demands and market expectations.

• Inflation vs. Dollar Value: A weaker dollar boosts import inflation, complicating Fed policy further.

• Stability Risks: The twin surge in yields and dollar weakness is raising red flags for systemic stability.

  
  

Strategic Changes by Global Central Banks

• Diversified Reserve Holdings: Central banks are accelerating moves to reduce dollar dependence, adding more gold, euro, and yuan holdings.

• New Currency Agreements: Bilateral and multilateral payment systems are being developed, particularly in Asia.

• Tech Innovation: Blockchain-based payment systems and CBDCs offer alternatives to dollar-dominated settlements.

Impact on South Korea

Changing Export Competitiveness

• New KRW-USD Dynamics: A weakening dollar may put upward pressure on the won, hurting Korea’s export competitiveness.

• U.S. Trade Uncertainty: Trump's protectionist policies could force Korean companies to rethink their U.S. strategies.

• Semiconductor and Auto Industries at Risk: Samsung, SK Hynix, Hyundai, and Kia face dual pressures from the U.S.-China conflict and dollar weakness.

  
  

Shifts in Financial Markets

• Reevaluating Bond Holdings: Korean institutional investors may need to reassess their large U.S. Treasury positions.

• Higher Hedging Costs: Exchange rate volatility is expected to raise FX hedging costs for Korean firms.

• New Investment Opportunities: A weaker dollar and stronger Asian currencies may open overseas investment opportunities for Korean investors.

Practical Investment Guide

Portfolio Restructuring Strategies

• Reduce Dollar Exposure: Consider lowering dollar asset share from 60–70% to 40–50%.

• Expand Currency Diversification: Increase exposure to euros, yen, francs, and selectively, the yuan.

• Increase Real Asset Allocation: Boost holdings in gold, real estate, and commodities to hedge against currency depreciation.

• Volatility Management: Use derivatives like options and futures for dynamic hedging strategies.

  
  

Corporate Financial Management Tips

• Review FX Hedging Policies: Shift from dollar-only hedges to multi-currency strategies, and increase hedge ratios.

• Diversify Revenue Currencies: Expand revenue in non-dollar currencies to naturally hedge FX risk.

• Restructure Supply Chains: Adjust global sourcing to reduce exposure to dollar volatility and U.S. trade risks.

• Cash Management: Reallocate surplus cash by currency and reduce dollar deposits.

Epilogue: The Dawn of a New Order

The dollar-centric international monetary system born at Bretton Woods in 1944 is now facing a profound challenge. Concerns over Trump’s policies and threats to Fed independence are more than market noise—they shake the very foundation of the dollar as the world’s reserve currency.

The breakdown of the U.S. Treasury–dollar correlation symbolizes this shift. Investors no longer view America as “risk-free.” That the U.S. is being priced like Greece or Italy is shocking—but real.

Yet this change doesn’t have to be negative. The weakening of dollar hegemony could lead to a more balanced monetary order. For middle-power nations like South Korea, it may even open new doors. What matters most is recognizing these changes and adapting accordingly. It’s time to move beyond old models, reassess traditional safe assets like Treasuries and the dollar, and embrace new strategies for risk management. A “new normal” is unfolding in global finance. To succeed in this era, we must abandon outdated playbooks and craft strategies fit for a new paradigm. Change brings both risk and opportunity. The outcome will depend on how we respond.