Are U.S. assets losing their luster?
“When the world gets riskier, people put their money into dollars […] that’s the American pattern…. What has people most scared is that the U.S. has switched its pattern from being a bastion of strength to trading like an emerging market." Lawrence Summers, New York Times, 14 April 2025.
Recent developments in financial markets are leading people to ask an uncommon question: are global investors, both domestic and foreign, losing faith in U.S. dollar assets? The most prominent evidence for a loss of confidence is the post-April 2 simultaneous decline in the U.S. dollar, the U.S. equity market, and U.S. bond prices, accompanied by a surge in the price of gold (see table below). There also are signs of a rising risk premium on those U.S. assets (Treasury issue) that had long been viewed as the safest on the planet (see here).
Previously, when a global shock sharply boosted market risk, investors fled into Treasuries. For example, at the start of the pandemic in March 2020, when the U.S. equity market plunged, bond prices and the dollar’s value rose. Remarkably, despite the near-collapse of the U.S. financial system, U.S. asset markets exhibited the same “safe-haven” mix during the 2007-09 financial crisis.
This time really has been different. As we see in the following table, during the first three weeks of April 2025, when volatility jumped and the S&P 500 equity index plunged by as much as 15%, Treasury yields at most maturities rose by up to 75 basis points and the dollar fell by a bit less than 6%. This worrisome combination of falling equity prices, bond prices and dollar value is reminiscent of the loss of confidence that frequently occurs when markets in emerging economies face adverse shocks. (In the same vein, Jiang et al note that sudden changes in the violations of the covered-interest-parity condition during this period point to an abrupt decline in the premium investors are willing to pay for safe dollar assets.)
U.S. Equity Prices, U.S. and German Bond Yields, and the Euro/U.S. Dollar Exchange Rate, intraday peak to trough changes in levels and volatility (dates in parentheses), April 1-22, 2025
Note: Dates of the peak and trough levels are shown in parentheses.
Sources: FRED, Yahoo Finance, MarketWatch, CNBC, and authors’ calculations.
To put things into a somewhat broader historical perspective, we updated the four-quadrant chart from a post that focused solely on the value of the dollar. On the vertical axis, we plot monthly changes since 1999 in the yield spread of 10-year Treasury notes over equivalent-maturity German government issues (Bunds). The horizontal axis shows the monthly percent change in the value of the U.S. dollar relative to the euro. So, when 10-year Treasury yields rise relative to 10-year Bunds, the dot will be in the top-half of the chart; and when the dollar appreciates relative to the euro, the dot is in the right-half.
Based on monthly average data, each blue circle represents the changes during a single month from January 1999 to March 2025. The solid purple dot plots the change from the March average to the average for the first 22 days of April 2025. Finally, the solid red dot is the change from 1 April to 22 April of this year. The shaded ellipse covers the area that is within a one standard-deviation confidence range around the origin. Since we view the observations within the ellipse as noise, our focus is on the points outside of the ellipse.
Monthly Changes in Currency Values and Yield Spreads: U.S. Dollar versus DM and Euro, January 1999 to April 2025
Note: Calculations all use monthly averages, except for April 2025. The purple dot shows the change from the March 2025 average to the average from 1 April to 22 April 2025 and the red dot shows the change from the 1 April level to the 22 April level. The shaded area is a one standard-deviation confidence (68%) ellipse around the origin. The percentage share of observations that fell in each quadrant and that are more than one standard deviation from the origin is reported in each green rectangle. Due to rounding, these percentages do not add to 100%.
Source: FRED, Yahoo Finance, CNBC, and authors’ calculations.
The chart shows that over half of the 74 observations outside the ellipse land in the first and third quadrants, where yield spreads and the Euro/Dollar exchange rate move in the same direction. Intuitively, these quadrants reflect cyclical patterns: when the U.S. economy outperforms (falls behind) that of the euro area, the yield spread rises (declines) and the U.S. dollar appreciates (depreciates).
The second and fourth quadrants include observations where the yield spread and the exchange rate move in opposite directions. More than one quarter of the observations outside the ellipse are in Quadrant IV – the optimistic one – where the U.S. dollar appreciates even though yield spreads appear to be making euro-area assets relatively attractive. Only one sixth of the observations outside the ellipse fall in Quadrant II – the anxiety zone – where the dollar depreciates despite a rise in U.S. yields compared to German yields.
Today, we are unambiguously in Quadrant II. Moreover, the solid purple dot is somewhat anomalous: based on the changes in monthly averages, there are only about one-half dozen other comparable observations. Perhaps more important, the large shift during April highlighted by the solid red dot seems consistent with the worried speculation of many observers that global investors have begun to shed U.S. assets. (See, for example, commentaries in the Economist, the Financial Times, and the Wall Street Journal, all between 9 April and 16 April.)
What can explain this recent adverse mix in U.S. financial markets? In our view, the candidate answers fall into three categories:
Changes in U.S. inflation expectations
Investors’ moving away from U.S. dollar assets
Deleveraging by hedge funds and other highly leveraged investors
In the remainder of this post, we briefly explore each of these possible explanations. Our focus is on what sort of information one would need either to confirm or discount each account. To state the obvious, since we are examining high-frequency events – movements in asset prices over hours and days – what we would need is high-frequency information. To foreshadow our conclusion, available data are insufficient to confirm the speculation that global investors are fleeing dollar assets. However, rather than an “all clear,” the implication of our current ignorance is that we need to remain vigilant. Worse, we may get little warning of more severe developments ahead. This risk leads us to believe that most entities in the financial system that are paying attention and can build resilience are now doing so.
U.S. inflation expectations
The most common explanation for observations in Quadrants II and IV is a shift of U.S. inflation expectations relative to that in the euro area. A favorable shift leads to Quadrant IV; an unfavorable one to Quadrant II. We think most observations in these two quadrants reflect changing relative expectations of inflation.
And, because the U.S. tariffs tend to be inflationary at home and deflationary abroad, a Quadrant II observation seems natural. Indeed, the University of Michigan survey of U.S. consumers shows a substantial increase in one-year-ahead inflation expectations from 4.3% in February to 5.0% in March and to 6.7% in the preliminary April estimate (see here). In financial markets, the steepening of the U.S. yield curve during April also is consistent with a rise of inflation expectations. Furthermore, market-based inflation expectations computed from nominal and inflation-indexed U.S. Treasury bonds now tend to support this hypothesis. For example, five-year, five-year forward market-based expectations of inflation – that is, of expected inflation from 2030 to 2035 – show a very modest increase from 2.15% on 1 April to 2.19% on 21 April.
In practice, it will be market developments themselves – especially movements in forward inflation expectations – that confirm or reject inflation expectations as a key driver of the adverse market shifts.
Investors’ attitudes toward U.S. dollar assets
A shift away from U.S. dollar assets – selling by both private and public sector investors – could readily explain the adverse market mix in April.
There are two main reasons that people would shift away from American equities and bonds. First, while tariffs raise revenues, the tariff shock may have aggravated concerns about U.S. long-run fiscal sustainability. The rationale is that sustained high tariffs eventually tend to lower the path of real GDP.
Second, there could be increasing fear about the United States willingness to uphold the rule of law and the sanctity of contracts. The trade war makes it clear that the current U.S. President is no longer willing to honor even those international agreements that his previous Administration negotiated. Will investors now fear that this penchant for treaty abrogation will extend to the property rights and contracts foreigners have with U.S. entities? Will global investors come to expect capital controls, such as taxes imposed on foreigners’ holdings of U.S. assets (see, for example, the outline for such a “user fee” in a November paper by the current Chair of the Council of Economic Advisers)?
This concern may be even broader: How are increased doubts about the reliability of U.S. policy management shaping global investors’ attitudes toward the safest U.S. assets? For example, how will people respond to President Trump’s repeated and elevated attacks on the Federal Reserve Chair? The latest market developments strongly suggest that the President’s threats cause U.S. assets to lose value. Indeed, attacks on central bank independence are far more consistent with the governance in an emerging market country than with that in a global safe haven.
Not surprisingly, many jurisdictions are now taking actions to insulate their economies and financial systems from future shocks emanating from the United States. However, there may be no early warning of seriously adverse developments in financial markets. For example, even if global investors currently assign only a very small probability to U.S. capital market interventions, the odds of a run – a “sudden stop” (see our primer here) – could surge if policy expectations shift. Such a balance of payments crisis typically triggers a collapse in the domestic economy, in the prices of its domestic assets and in the value of its currency. In terms of our four-quadrant chart, the dot would be in Quadrant II, but far up and to the left of the range we drew.
Aside from such increasingly widespread speculation, what do we actually know from market and other data?
So far, there is little public data (other than market prices) indicating that global investors are fleeing U.S. assets for those elsewhere in the world. For example, if we look at foreign ownership of U.S. Treasury securities, where we have data through February 2025, total holdings are currently $8.82 trillion, up from $8.53 trillion in January. Official holdings also are up very slightly from $3.81 trillion to $3.90 trillion. Even Chinese official holdings are up from $761 billion in January to $784 billion. However, we will not see data for April until the latter half of June. By that time, these volume measures probably will contain little new information not already revealed by shifting market prices.
There is some higher-frequency volume information available. On a weekly basis, the Federal Reserve publishes information on its custody holdings and on reverse repurchase agreements (repo) with foreign official sector entities. Here the latest data show nothing that is out of the ordinary. For example, custody holdings edged up from $2.93 to $2.94 trillion since end-March, while reverse repo slipped from $388 billion to $358 billion over the same period. Taking a broad perspective, these changes strike us as small.
For private investors, we have even less information. Some firms produce higher-frequency surveys of portfolio managers, as well as data on mutual fund flows. However, these data are proprietary. Moreover, public reports about these data tend to be anecdotal, rather than serious statistical explorations of the hypothesis that global investors are engaged in a large, secular shift away from U.S. dollar assets.
Weekly data from Japan’s Ministry of Finance show sizable net sales of long-term international securities by the country’s institutional investors at the start of April. However, the pace was not a record, and it slowed sharply in the second week of the month. Moreover, monthly readings through March were unexceptional. In any case, we do not have a currency breakdown for these transactions.
Another general caution about data on asset holdings is in order. While we may know the nationality of the registered owner of a security, we do not know where the beneficial owner resides. So, for example, if a Chinese firm opted to hold U.S. Treasury securities through an entity in the Cayman Islands (where holdings of $400 billion worth currently are registered), we would have no way of knowing the identity of the owner. Similarly, if a private investor holds any U.S. assets through entities in Ireland, we would know only that they are registered to an Irish entity. In other words, if beneficial owners – both private and public – wish to conceal their identity, they probably could defeat almost anyone’s ability to find out what they own (or what they sell).
Pressure on market participants to deleverage
The third item on our list of possible explanations for the April financial market turmoil is that firms were compelled to deleverage. Consider, for example, the U.S. Treasury “basis” trade, where market participants – usually hedge funds – try to exploit the gap between the cash price and the futures price of a Treasury security. Their goal is to profit by purchasing one and selling the other, and they are hedged (insured) against shocks that move both prices in the same direction. Frequently, the investor in a basis trade will borrow money using short-term repurchase agreements and engage in a futures contract to either deliver or purchase the bond at a later date. (For a detailed description see here.)
Two things can go wrong with this arrangement. The first is that the counterparty to the repurchase agreement may need either the cash or the security and decline to extend (“roll over”) the daily repo. Second, the futures exchange requires entities engaging in contracts to deposit funds (“margin” or collateral). The purpose is to ensure that they will make good when the time comes. In practice, the investor could face a margin call because the market moved against her position, volatility prompted the exchange to increase margin requirements, or both. As we know from unpleasant experience, margin calls are often associated with liquidity crises, while big declines in asset prices can trigger insolvency cascades.
The idea is that as equity and Treasury bond prices started to fall, investors suddenly needed cash (see Kashyap and Stein here and here). Moreover, the unusual co-movement of bond and equity prices likely boosted cash needs markedly because a portfolio involving both assets was suddenly far riskier than when their prices moved inversely. Heightened cash needs mean both that the funds engaging in these trades were unwilling to lend and that they might be forced to sell their safest securities. A spiral of rising volatility, heightened margin calls, and rising cash needs may well have contributed to the April steepening of the yield curve.
However, the unwinding of the U.S. Treasury basis trade alone does not explain the April depreciation of the dollar. And it is this last bit that lands us in Quadrant II of our chart and is so worrisome. To get this final piece based only on market fragilities, we need to add in a cross-border trade – such as one where investors buy or sell a U.S. Treasury security, do the opposite for the German Bund, and engage in a euro/dollar futures contract to eliminate the interest rate risk. If a fund were forced to close out that Treasury/Bund basis trade in a way that makes euros scarce, then we land in Quadrant II. The evidence in Jiang et al. on the dollar-euro basis trade indicates that this did happen, helping to explain the dollar’s decline.
However, we do not have information on the quantities involved in these trading strategies. There are some data on U.S. dollar repurchase agreements available monthly (here), and for primary dealers we have weekly information (here). There also exists high-frequency information about open interest, trading volume and bid-ask spreads in futures markets. Again, however, we see nothing exceptional in this high-frequency public data. So, in the end, we cannot yet determine the extent to which deleveraging contributed to the financial market turmoil we saw.
Concluding Comments. This analysis leads us to draw the following tentative conclusions. First, the configuration of falling equity prices, rising yields, a depreciating currency, and a surging price of gold is very concerning. Second, the simplest hypothesis is the most troubling: that global investors are losing confidence in the United States and fleeing U.S. assets and the dollar. However, at this point, we have little hard data to confirm this bleak proposition. Indeed, from the available public information, foreign governments have not yet shifted reserves out of U.S. dollars. And, there are other factors (inflation expectations and deleveraging) that also could help explain the observed market fluctuations.
What is the bottom line? Investors and policymakers need to remain on active watch for hard evidence that people are losing confidence in U.S. assets. A return to the “safe-haven” pattern – where U.S. bond prices rise as equities fall and the dollar appreciates – would relieve the underlying anxiety. However, there may be very little warning of an intensified shift away from U.S. assets. If that happens, it will be too late to find low-cost ways to “de-risk” exposure to further chaotic U.S. policy developments.
Acknowledgments. We thank our friends, Richard Berner, John Lipsky, Ahmad Namini, Catherine Rampell, and Nicholas Sargen, for their very thoughtful questions and suggestions.