Some people argue the concurrent dollar decline and Treasury yield incrase was attributable to liquidity issues as repicing occurred against a backdrop of a rising share of price sensitive Treasury holders. Others that it was a flight away from the US dollar assets spurred by tariff uncertainty (see a discussion here). Here’s the picture people know, the dollar vs. US Treasurys:
Figure 1: Nominal dollar against advanced economies currencies (blue, left scale), and 10 year US Treasury yield, % (tan, right scale). Source: Federal Reserve, Treasury, via FRED.
And here are two graphs from Helene Rey and Vania Stavrakeva, “Interpreting Turbulent Episodes in International Finance”, keynote presented at the Asian Monetary Policy Forum (Singapore, 2025). (My discussion here).
The first is the reaction of the exchange rate to equity flows during the pandemic. The foreign currencies weakened as imputed equity flows moved to the US.
Source: Rey, Stavrakeva (2025).
In contrast, in 2025 around “Liberation Day”, other currencies strengthened as imputed equity flows moved out of the US.
Source: Rey, Stavrakeva (2025).
So, while I don’t discount completely the idea of illiquidity in the Treasury market as a driver of the increase in Treasury yields around “Liberation Day”, it seems to me that at least part of the shift post-“Liberation Day” is due to the decline in the confidence in the dollar. While the correlation in changes in the dollar’s vale and in the Treasury yield have re-asserted itself, it’s interesting that in Figure 1, the gap that widened in the levels has persisted.
This is not an either/or situation. A sudden episode of illiquidity neccesarily occurs in stages, the first being some precipitating event. If there had been no shock, there would not have been a liquidity problem.
The ultimate cause was pretty obviously the felon-in-chief’s jaw-dropping tariff announcement, in redponse to which there needed to be a precipitating market event, a proximate market cause, to induce a liquidity shortfall. There were more dollars and Treasuries on offer than market makers could easily handle, when normally there is no such problem. That initial wave of selling is where we see a loss of confidence.
Sure, a liquidity shortage means there is a structural problem, relative to some level of turnover in the market, but why the increase in turnover? And why selling? It cannot be MERELY an episode of illiquidity.
Treasury and the Fed, primary dealers and brokers need to address the structural problems Nellie Liang raised in her testimony. That’s their bailiwick. They and everyone else need to recognize the risk inherent in bad policy that was spotlighted when the felon-in-chief had his Liz Truss moment.
It’s dominos. Truss and Trump both caused loss of confidence which then caused the waves of selling which caused liquidity problems.