Why do higher treasury yields support stronger USD?

Question

In the wake of the blue wave, US treasuries (TLT for example) have sold off in anticipation of massive fiscal stimulus. The expectation presumably is that the stimulus will lead to inflation, which will in turn result in tightening of monetary policy; essentially a higher return on "no risk" investments.
We have consequently seen USD (DXY) trend up, and publications ranging from Bloomberg to the Wall Street Journal stating that higher yields support a stronger dollar. Obviously more dollars should result in depreciation thereof so on the surface this is counter intuitive...

Could it be that the expectations of tightened monetary policy, with better yields on longer term (USD-denominated) government debt sometime in the future will result in greater demand for USD, hence its recent appreciation?

quickshiftin · Answer

Having conducted my own research I will posit the following answer -

Fiat currencies reflect the strength of the economy for the country they represent (reference)

...the government is the strength and the reason fiat money has value.
The money has value because the government says it does.

Fiscal stimulus is said to be more potent than monetary stimulus:

In comparing the two, fiscal policy generally has a greater impact on
consumers than monetary policy, as it can lead to increased employment
and income.

In the book The Dollar Trap it is stated

Economic theory predicts that a country undertaking fiscal expansion -
through some combination of cutting taxes and increasing government
expenditures - would see its currency appreciate.

So it seems that broadly speaking, the expectation is that the US economy will strengthen in the wake of the upcoming fiscal stimulus, thereby increasing the value of its currency.
Treasury yields, in particular ones with longer maturities are a reflection of this expectation, the presumption being the Fed will tighten monetary policy sooner than previously anticipated.

Why do higher treasury yields support stronger USD?

One Answer

Add your own answers!

Ask a Question