US Treasury Yields and the Dollar Decouple: Asset Pricing Under Fiscal Dominance

The "Abnormal" Divergence Between Yields and the Dollar Since August 2026, global markets have displayed a striking anomaly: the 10-year US Treasury yield has hovered near 4.7%, close to a 19-month high; the 30-year yield has briefly risen above 5%, the highest since 2007; yet the US dollar index has weakened for three straight weeks, falling below 98.5. Under the traditional macro framework, high yields should attract capital into dollar assets and support the greenback. Today, the two are diverging. The market is repricing the rise in Treasury yields: it no longer reflects only growth and rate-hike expectations, but increasingly compensates for US fiscal sustainability and sovereign credit risk. Fiscal Dominance: Debt, Deficits, and Central-Bank Independence "Fiscal dominance" has become the central concept explaining this divergence. MSCI research defines it as a situation in which the scale of government debt forces the central bank to trade off inflation control against fiscal stability. The US federal deficit is currently around 5.8% of GDP, and debt held by the public has reached 101% of GDP, projected to rise to 120% by 2036. Natixis analyst John Briggs warns that the Trump administration's challenges to Federal Reserve independence are undermining confidence in Treasuries, and the Supreme Court will hear a related appeal in January, which could become the biggest threat to the Treasury market since April's "Liberation Day." Once markets believe monetary policy is being subordinated to fiscal needs, long-term inflation expectations and term premiums will rise together. Rising Term Premiums and Foreign Demand The term premium is the extra compensation investors demand for holding long bonds rather than rolling short-term debt. An EBC analysis argues that fiscal dominance will push term premiums higher, because investors worry that governments may resort to inflation or financial repression to manage debt. The US Treasury's expansion of long-bond buybacks was intended to suppress long-end yields, but instead deepened market concerns about dollar-credit dilution. Overseas investors and central banks are reassessing their Treasury allocations: the World Gold Council reported that global central banks net-purchased 289 tonnes of gold in Q2 2026, up 62% year-on-year and the highest quarterly buying in nearly four years. The People's Bank of China has increased gold reserves for 21 consecutive months. This reflects a long-term hedge against dollar-credit risk. Gold Reassessed as a Dollar-Credit Hedge Gold's recent strength is the most direct price expression of the fiscal-dominance narrative. Traditionally, high real rates are gold's biggest headwind because gold pays no interest. Yet in 2026, gold has repeatedly hit new highs even as the 10-year Treasury yield remains near 4.7%, indicating that gold's pricing anchor is shifting from real rates to dollar-credit hedging. In other words, the market is trading not only the Fed's rate path but also the long-term sustainability of US public finances. Suki Cooper, global head of commodities research at Standard Chartered, said central-bank buying, geopolitical uncertainty, and portfolio diversification demand remain strong, and gold could head back toward USD 5,000/oz. Implications for Global Asset Allocation Under the shadow of fiscal dominance, the global asset-pricing framework is undergoing structural change. First, Treasuries can no longer be treated as purely risk-free assets; their risk premium must incorporate sovereign credit and political uncertainty. Second, the traditional positive correlation between the dollar and yields is weakening, so investors must pay more attention to fiscal indicators such as twin deficits and debt-to-GDP. Third, gold, commodities, and selected non-dollar currencies may serve as hedges against dollar-credit risk. For A-shares and Hong Kong stocks, a weaker dollar helps ease capital-outflow pressure, but a decline in global risk appetite due to Treasury volatility could also bring intermittent turbulence. Jackson Hole will be a key window for observing how the Fed responds to fiscal-dominance concerns.