From Treasury yields, Dollar, to Currency Wars: Demystifying the U.S. Debt Market
Q5: Why Do U.S. Treasury Yields Rise? And, How Can Market Volatility Affect it?
Treasury yields can rise due to:
- Higher Federal Reserve interest rates: New debt must offer higher yields to remain attractive.
- Inflation expectations: Investors demand higher yields to offset reduced purchasing power.
- Lower demand: If investor appetite for Treasuries falls, yields must rise to entice buyers.
- Increased supply: Large-scale issuance (e.g., due to budget deficits) can depress prices and lift yields.
- Economic optimism: Investors shift from bonds to stocks, reducing demand and increasing yields.
- Foreign divestment: If foreign central banks reduce holdings, bond prices drop and yields rise.
Typically, during stock market volatility or crashes, investors move into U.S. Treasuries for safety. This increases bond prices and lowers yields.
However, in extreme cases (e.g., rapid margin calls), investors may be forced to sell Treasuries to raise cash, causing bond prices to fall and yields to rise temporarily. This is a liquidity-driven sell-off, not due to changes in inflation or fundamentals.
Q6: Why Are Higher Treasury Yields Problematic for the U.S. Government?
- Increased borrowing costs: Higher yields raise interest payments on new debt, impacting the federal budget.
- Larger deficits: More interest payments reduce room for discretionary spending unless taxes are raised or spending is cut.
- Reduced fiscal flexibility: High yields constrain the government’s ability to fund new programs or respond to crises.
- Debt sustainability concerns: Rising debt and yields may lead investors to demand risk premiums, worsening the cycle.
- Global implications: If yields rise due to inflation or political risk, foreign investors may pull back, weakening confidence in U.S. assets and the dollar.
Q7: Do Foreign Governments Hold Different Types of Treasury Securities?
Foreign governments hold all three types (T-bills, T-notes, and T-bonds) of securities, though they primarily hold T-notes and T-bonds (especially 10-year and 30-year issues). These securities:
- Serve as foreign exchange reserves
- Are considered safe, liquid, and globally accepted
- Help stabilize exchange rates and back up national currencies
Countries with large trade surpluses with the U.S. receive dollars and often reinvest them in Treasuries. This also helps them maintain weaker currencies and competitive exports.
Q8: How Do Foreign Countries Use U.S. Treasuries to Influence Their Currencies? And, What Is Currency Manipulation in Global Trade?
Countries with large trade surpluses can accumulate U.S. dollars. Instead of converting these dollars into local currency (which would strengthen it), they:
- Buy U.S. Treasuries
- This maintains demand for the dollar
- And suppresses demand for their own currency
By doing so, such countries can keep their currency artificially weak, helping sustain an export advantage — a form of currency management, and potentially manipulation if done persistently and strategically.
Currency manipulation occurs when a country intentionally interferes in foreign exchange markets to keep its currency undervalued, making exports cheaper and more competitive. While not illegal, it’s criticized when it distorts trade balances, harms trading partners, and involves excessive accumulation of foreign reserves (e.g., U.S. Treasuries).
The U.S. Treasury monitors this behavior and may designate countries as manipulators based on trade surpluses, currency intervention, and lack of transparency. See this Wikipedia page for more information on US Treasury securities.
Q9: Typically, Treasury Yields Go Down When the Dollar Falls (i.e., More Treasury demand). But, Can Treasury Yields Rise While the Dollar Falls?
Yes — although unusual, it can happen in certain scenarios:
- Loss of fiscal credibility: Investors worry about U.S. deficits or political dysfunction, selling both Treasuries (raising yields) and dollars (weakening the currency).
- Stagflation: Inflation surges while growth stalls; investors demand higher yields but flee the dollar due to eroding purchasing power.
- De-dollarization: Foreign governments reduce dollar holdings for geopolitical or strategic reasons, causing yields to rise and the dollar to weaken.
- Global capital retreat: Simultaneous selling of U.S. assets and foreign repatriation can drive yields up and the dollar down — often seen during systemic shocks.
