US treasury yield and the USD, typically positively correlated, have diverged sharply since the tariff tantrum (announcement, pause, escalation with China and exemptions). What could be the drivers?
1) Global asset allocation change (reassessment of US policy & asset credibility, and diversification)
2) Heavily overweight & concentrated long-USD positions (‘US exceptionalism’ trade) in the last few years
3) Policy induced financial market volatility and economic uncertainty (stagflation?)
4) Further potential deterioration in the US fiscal outlook (extension of Tax Cuts and Jobs Act, etc.), higher borrowing and interest rates
5) Possibly weaker Fed ‘put’ to support growth, given the recent pandemic-driven high inflation experience & already high price levels (which impact the lower income segment more), current inflation is still above the 2% target (how much and for how long will the tariff passthrough impact add?), and the likelihood of Fed facing tension between its growth and inflation mandates
6) Technical factors – margin calls and unwinding of ‘basis trades’
7) Watch out for – Fed independence, purchase/sale of US treasuries by other countries
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