What does the rising dollar tell us? Theoretically, it tells us that the demand for the dollar remains strong. But we cannot see it in isolation. We must take into account what is happening alongside the dollar.
Currently, the US Treasury yields are rising sharply. The 10-year yield is around its highest level since 2007, the 30-year yield is at its highest since 2004, and the two-year yield is approaching 5%. At the same time, the dollar is near a two-month high.
Usually, yields and currencies go hand-in-hand. The logic is simple. When yields are high, investors flock in and demand for that currency rises. That's what has happened with the US dollar and Treasury yields too. But the story isn't so simple.
Four Forces Driving The Dollar
Looking at daily data from 2021 to 2025, Steven Kamin of the American Enterprise Institute found four forces that consistently moved the dollar. They were: US interest rates relative to other countries, the shape of the US yield curve, market fear and oil prices.
When US short-term interest rates rose relative to other countries, the dollar generally benefited because US assets offered better returns. The same logic applies when US long-term rates rise faster than short-term rates compared to elsewhere.
For example, suppose the US 2-year yield remains at 4%, and the 10-year yield rises from 4.5% to 5.5%. The gap between the two increases from 0.5 percentage points to 1.5 percentage points, making the yield curve steeper. If long-term yields in other countries rise by less, US assets become relatively more attractive, which can support the dollar.
The third factor is fear, measured by the volatility index, or VIX. Investors usually move towards the dollar as a safe-haven asset if VIX rises. Finally, higher oil prices also supported the dollar because the US is a major oil producer and net exporter.
These four forces provide a useful starting point for understanding what has been happening to the dollar.
Aftermath Of The West Asian War
When the war in Iran began on February 28, the dollar, VIX and oil prices rose almost simultaneously. This event impacted currencies differently.
Higher oil prices pressured several Asian and European countries. Their currencies weakened. The US remained unaffected, strengthening the dollar's position. Heightened financial uncertainty supported the dollar, as expected.
By May, ceasefire hopes brought oil prices down, shedding some pressure on several central banks to raise rates. But within a month, the Federal Reserve started sounding more hawkish and that raised yields. The rate differential between the US and other countries favoured the dollar.
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Something Changed Since The ‘Liberation Day'
Kamin's September piece in Barron's adds more insights on where the relationship between yields and the dollar will go.
We discussed how the steeper yield curve supports the dollar. Kamin finds that this relationship changed after the April 2025 ‘Liberation Day' tariffs. Since then, when the US yield spread has risen relative to yield spreads elsewhere, the dollar has sometimes weakened.
The impact on short-term and long-term yields is different.
The two-year yield continues to support the dollar because it is closely linked to expectations about what the Federal Reserve will do with interest rates. When markets expect the Fed to keep rates higher, two-year yields rise, and the dollar tends to benefit.
The 10-year math has got complicated. For a given level of two-year yields, a rise in US 10-year yields relative to yields in other countries is now associated with a weaker dollar, not stronger dollar as discussed in the previous example. This does not tell us exactly why investors are demanding higher yields.
If the 10-year yield rises because investors expect stronger growth or tighter Fed policy, the dollar can continue to benefit. If it rises because investors are worried about inflation, heavy government borrowing or the sustainability of US debt, the dollar could respond differently.
That is the question Kamin is asking us to watch.
What Happened In The Last Few Weeks
The latest market moves have brought several of these forces together again. Oil prices have risen over the last couple of days, Treasury yields have moved higher, and the dollar has strengthened too.
There is now more than a 70% probability of a US rate hike at the end of October, up from 57% a week earlier. The upcoming inflation and jobs data could therefore be important for the Fed's next decision and, in turn, for the dollar. Other developed economies are also moving towards tighter monetary policies. Together, these developments are pushing yields higher and making the relative interest-rate picture important for the dollar.
Whether higher yields translate into a stronger dollar, however, will depend on how investors view US assets. So far, the market is still showing strong demand for US assets. The latest data suggest that demand for US equities has remained strong.
Reuters reported that US equity funds attracted $37.6 billion in net inflows in the week ended September 25, their largest weekly inflow since June 17. But the demand for US government debt has weakened.
Final Take
Currently, higher short-term yields, expectations of further Fed tightening, oil prices, the AI boom, corporate earnings and geopolitical risks are all supporting the dollar. That does not settle the debate about the dollar's longer-term position. It tells us that, at this stage, the market is still willing to hold US assets.
However, the Treasury market is facing pressure. They are perceiving the reality differently.
Therefore, tracking the dollar alongside the composition of capital flows can help us understand how investors are viewing US assets.
Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.
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