Moody's, one of the three major global credit rating agencies, downgraded the United States' sovereign credit rating in May last year from the top tier "Aaa" to one notch lower at "Aa1." Then the 10-year U.S. Government Bonds yield rose to 4.5% a year (bond prices fell). As concerns emerged over U.S. creditworthiness, investors rushed to sell Government Bonds, pushing prices down.
But the dollar index (the value of the U.S. dollar against the currencies of six major countries) fell from 103 in April last year, before the downgrade, to 98 in June and failed to recover to 100 by year-end. In a report in July last year, global custodian bank State Street analyzed that "the historical correlation between U.S. Treasurys and the dollar has broken."
Traditionally, U.S. Government Bonds yields and the dollar's value have tended to move in the same direction. When U.S. Government Bonds yields rose, investors around the world bought bonds, a safe asset with higher yields, boosting dollar demand. Higher yields were also read as a sign the U.S. economy was improving, increasing the appeal of dollar-denominated assets.
Analysts say this correlation has broken because the recent rise in U.S. Government Bonds yields stems from uncertainties that worsen investor sentiment toward the United States, such as "widening fiscal deficits," "declining national creditworthiness," and "policy uncertainty under the Trump administration."
◇ Concerns over wider fiscal deficits and lower creditworthiness... the status of U.S. Government Bonds as the "safest asset" is wavering
This year, while the 10-year U.S. Treasury yield climbed from the low 4% range in February to as high as 4.66% in May, the dollar index has held in the high 90s.
Analysts say the breakdown of the "rising U.S. Government Bonds yields-strong dollar" formula is because the investment appeal of dollar-denominated assets, including Government Bonds, has diminished amid worries over widening fiscal deficits and lower creditworthiness. The Congressional Budget Office (CBO) projected that the U.S. fiscal deficit will reach $1.95 trillion (about 2,947 trillion won) in the fiscal year ending in September.
If the government increases Government Bonds issuance to cover the deficit, bond prices fall (yields rise), which in turn increases the government's Government Bonds interest burden, creating a vicious cycle that heightens fiscal concerns.
Recently, demand for U.S. Government Bonds has cooled. On Apr. 12, when the 10-year U.S. Treasury yield rose to the mid-to-high 4% range, the bid-to-cover ratio in a $42 billion 10-year new issue auction was just 2.4 times. That was lower than the recent six-month average of 2.47 times.
Major countries are also dumping U.S. Treasurys in large volumes. According to the U.S. Treasury Department, as of March, other countries' holdings of U.S. Government Bonds stood at $9.348 trillion (about 14,100 trillion won), down $139.1 billion (about 210 trillion won) from the previous month. Of the top 10 foreign holders of U.S. Government Bonds, seven—including China, Japan and Canada—reduced their holdings.
Bank of America said in a report on the 25th of last month that while high oil prices spurred inflation and triggered massive selling in the bond market, "concerns over the United States' fiscal soundness are the dominant driver in markets."