Signs of unease emerge! The ‘earthquake’ in the US dollar begins to ripple through the US bond market. Is inflation becoming a concern?

Cailian Press, January 28 (Editor: Xiaoxiang) The latest signs indicate that the sharp fluctuations in the US dollar are beginning to spill over into the US Treasury market, which could serve as an early warning signal that a weak dollar has the potential to push up long-term interest rates.

As shown in the chart below, during the late trading sessions on Tuesday and Wednesday in the US, fluctuations in the dollar exchange rate triggered intense reactions in the US Treasury market. This marked a stark contrast to the situation from the previous week—when despite the Bloomberg Dollar Index falling more than 2.5% to its lowest level in nearly three years, the bond market remained indifferent.

On Tuesday evening local time, after President Trump stated that he was not concerned about the depreciation of the dollar, the currency experienced a sharp short-term plunge. On Wednesday, however, the dollar rebounded sharply in the short term after US Treasury Secretary Bessent denied that the US was planning any currency intervention measures.

It is not difficult to observe that in the past two days, as the dollar fell, long-term Treasury yields surged significantly, while the subsequent rebound in the dollar coincided with a rapid decline in yields. These fluctuations reflect the possibility that currency depreciation could eventually evolve into inflation, which is undoubtedly an implicit rebuke to a US government claiming to be committed to lowering borrowing costs.

George Goncalves, head of US macro strategy at Mitsubishi UFJ Securities Americas, pointed out, “The fate of the US bond market, particularly long-term bonds, is closely tied to the dollar. When yields in countries such as Japan have become sufficiently attractive to domestic investors, a weakening dollar that triggers inflation would backfire.”

Another notable phenomenon observed over the past two days is that as Treasury yields rose, Treasury Inflation-Protected Securities (TIPS) outperformed benchmark Treasuries, while underperforming when yields declined—a further set of indications that fluctuations in the dollar are being viewed as a potential catalyst for inflation.

During Tuesday’s dollar sell-off, the valuation of Treasuries relative to interest rate swaps declined, indicating that bonds were being sold off, and based on related options activity, indicators measuring long-term interest rate volatility increased.

Analysts noted that the recent rise in Treasury yields has been primarily concentrated in long-term Treasuries, driving the 30-year Treasury yield up by approximately 7 basis points relative to the 2-year Treasury yield, marking the largest single-day increase in several months. When the bond market exhibits a classic ‘bear steepener’ pattern—where long-term yields rise faster than short-term yields—investors typically anticipate that inflation may reaccelerate.

Looking ahead, a continued weakening of the dollar could further reduce foreign investors’ appetite for US Treasuries—currently, about one-third of US Treasuries are held by overseas investors. If dollar volatility persists, it could deepen the risk spiral of ‘selling America’ trades in financial markets at the start of this year.