The dollar stops acting like a safe haven

The Dollar Index has fallen below 100 even though benchmark 10-year Treasury yields are hovering near 4.5 per cent. For decades the dollar rallied whenever the world grew nervous. This time it has not, and its usual link to Treasury yields and to flights to safety has broken.

The index, which measures the dollar against six major currencies, began the year above 108, buoyed by expectations that tariffs and American growth would keep it strong. It has fallen steadily since, and the fall accelerated after the reciprocal tariffs were announced on April 2nd. The euro, the yen and the Swiss franc have all gained sharply. In the same weeks, ten-year yields swung from around 4 per cent to 4.5 per cent, the kind of rise that would normally pull money into the dollar.

Higher yields, weaker dollar

In the past, when US yields rose because financial conditions were tightening, foreign money poured into the dollar to earn the wider yield gap. That no longer happens. International investors are declining to chase higher American yields because they see them as a sign of looser fiscal discipline and weaker governance. Strong productivity growth with low inflation is not what they read into the numbers.

A currency that weakens as its bond yields rise is behaving like an emerging-market currency, where higher yields signal risk rather than reward. Economists usually associate that pattern with worries about a country's public finances or institutions. The clearest recent example in a rich country was Britain in September 2022, when an unfunded package of tax cuts sent gilt yields soaring and sterling to a record low against the dollar at the same time. America's fiscal position is not the direct trigger this time, but deficits of more than 6 per cent of GDP leave little margin for a loss of confidence.

Hedging, not dumping

The mechanism need not involve foreigners selling American assets outright. Many large holders, such as European pension funds and Asian life insurers, own American shares and bonds without fully hedging the currency risk, because the dollar used to rise when those assets fell and so provided its own protection. If that relationship breaks, the rational response is to hedge more of the exposure by selling dollars forward. Even a modest increase in hedge ratios across trillions of dollars of foreign holdings creates heavy selling pressure on the currency without a single bond or share changing hands.

The cost of hedging depends on the gap between American and foreign short-term interest rates, which is wide, so hedging is expensive. That so many investors appear willing to pay it tells its own story. Fresh buyers, meanwhile, have less reason to add to American holdings at all, and some have begun to rebalance towards European and Asian markets.

Gold and francs instead

When trade policy flares up, global reserve managers and family offices now buy gold, Swiss francs and decentralised stores of value rather than the dollar. Using trade barriers as weapons and changing policy without warning have cost America some of the institutional credibility on which the dollar's dominance as a reserve currency rested.

Gold has been the clearest beneficiary, rising above $3,300 an ounce this week to a record. Central banks, particularly in emerging markets, have been buying it heavily since Western governments froze Russia's foreign-exchange reserves in 2022, a move that showed reserves held in dollars could be immobilised by political decision. The Swiss franc, a traditional haven, has rallied too, although the Swiss National Bank has long resisted a strong currency, and the yen has regained ground against the dollar.

Why credibility is in question

The worries are specific. Tariffs have been announced, suspended, raised and exempted within days. The president has publicly attacked the chairman of the Federal Reserve this week and suggested that he would like him gone, raising doubts about the central bank's independence. Some of the administration's advisers have argued openly that the dollar is overvalued and that foreign holders of Treasuries might be asked to bear some of the cost of the reserve role, for example by swapping into longer-dated bonds. Such ideas remain proposals, but investors price possibilities as well as policies.

There is precedent for a policy-driven fall in the dollar. In 1971 Richard Nixon ended the convertibility of the dollar into gold, and the currency fell through the decade as inflation rose. In 1985 the Plaza Accord engineered a deliberate depreciation. In both cases the dollar kept its role as the main reserve currency, because no alternative offered comparable depth and liquidity. That remains true today: the euro area has no single safe asset on the scale of Treasuries, and China's capital controls rule out the yuan.

Who gains from a weaker dollar

American exporters and multinationals that earn revenue abroad gain, since their foreign earnings translate into more dollars. Emerging-market borrowers with dollar debts find repayment cheaper. European and Japanese exporters lose competitiveness at the worst possible moment, as they also face American tariffs. American consumers pay more for imports twice over, once through tariffs and once through the currency, which adds to inflation and makes the Fed less likely to cut rates.

The strongest counterargument is that the dollar is simply correcting from an overvalued level, and that its fall is cyclical rather than structural. On that reading, once tariff policy settles and growth differentials reassert themselves, the usual relationships will return. Watch the dollar's behaviour on the next bad day for American shares, foreign purchases in the Treasury's monthly capital-flow data, the results of Treasury auctions, and any renewed attacks on the Fed's independence.

Foreign investors increasingly price unpredictable American policy as a risk to the government's own balance sheet, and the dollar will probably keep failing to rally in moments of stress for as long as that view holds. Expect the currency to stay weak through the 90-day tariff pause, with foreign investors hedging more of their American holdings and the cost falling on American consumers through higher import prices.