The falling Dollar won't hurt Treasuries

Think back to the days of Greenspan's "conundrum" - a weak Dollar means lower yields

In the run-up to the global financial crisis, the Fed was hiking steadily, partly in an effort to get a burgeoning housing bubble under control. At the time, one of the main things vexing the Fed and its then Chairman Alan Greenspan was the fact that longer-term interest rates refused to rise much. Those drive mortgage rates and their refusal to rise made it difficult to get house prices under control. In congressional testimony in Feb. ‘05, Greenspan called the stickiness of long-term Treasury yields a “conundrum.”

One of the leading explanations for this conundrum was the weak Dollar. Foreign central banks, especially in Asia, were intervening to stop their currencies from rising against the Dollar. This meant they were accumulating Dollars, which they invested in US Treasuries. The theory at the time was that this additional demand for Treasuries was preventing yields from rising as they normally would. Academic work since then has found this “flows” effect to be robust and sizeable.

The chart above shows foreign flows into all US assets from the Fed’s flow of funds. The red bars are foreign flows into Treasuries, where I’ve used red arrows to denote periods of Dollar weakness or strength. The key regularity is that when the Dollar is falling or weak, foreign flows into Treasuries are strong. When the Dollar is rising or strong, foreign flows into Treasuries are weak. Intuitively, this lines up with the idea that foreign central banks are buying Treasuries when the Dollar is weak and selling them when the Dollar is strong.

At the current juncture, this means a falling Dollar should actually be good for the Treasury market. Dollar weakness mobilizes new demand and - all else equal - puts downward pressure on longer-term yields. One pushback to this view, which I get a lot, is that the Dollar fell in April 2025 and yet the Treasury market was under severe strain. There’s actually no inconsistency with what I’m saying. The chart below shows the Dollar versus the G10 (blue line) and versus EM (black line). In the immediate aftermath of the reciprocal tariff rollout, the Dollar versus EM rose sharply because markets worried about China devaluing in retaliation to sky-high US tariffs. That Dollar strength saw EM central banks intervene to slow the fall of their currencies and they sold Treasuries as a result. Dysfunction in the Treasury market was due to a rapidly rising Dollar versus EM (where intervention in currency markets happens), much as was the case in March 2020 as well.

The bottom line is that a weak Dollar is good for Treasuries because foreign central banks turn into buyers. Historically, dysfunction in the Treasury market is associated with sharp increases in the Dollar, which is when EM central banks sell Treasuries, which upsets the basis and swap spread trades.