With Correlations Breaking Down, Diversification Matters More

The link between the U.S. 10-year yield and U.S. dollar is breaking

The historical link between Treasury yields and the U.S. dollar is breaking down. Usually, higher bond yields give the U.S. dollar a boost; the higher yield makes Treasuries attractive and so global investors demand U.S. dollars in order to buy them. Today, that relationship is at its weakest in three years. This could mark deeper-seated shift: markets may be starting to question the safety of U.S. assets in times of stress.

Why is this shift happening?

Global investors appear to be reducing exposure to U.S. Treasuries. Japanese investors, for instance, have shifted toward domestic equities amid policy uncertainty—a pattern we also saw during the Fed’s tightening cycle in 2022.

These moves are more likely driven by caution than retaliation. Investors are always seeking the highest return per unit of risk or effort, within the constraints they face (regulation, risk tolerance, etc.). We believe recent reallocations reflect public and private investors responding to policy uncertainty by shifting capital toward more stable or attractive opportunities.

One specific concern is that China could “dump” its Treasury holdings in response to U.S. trade policy. In our view, this risk is overstated. In 2011, China accounted for 30% of foreign-held Treasuries; today, that share is closer to 10%. As a portion of total U.S. public debt, China’s stake has fallen from 9% to just 2% - no longer large enough to meaningfully move yields. Meanwhile, the euro area has stepped in, now holding 8% of U.S. public debt.

Portfolio Strategy

Traditional “60/40” allocations rely on bonds as a ballast in times of equity stress. But if bonds and the dollar no longer act as safe havens, diversification may require a broader toolkit. We're seeing:

• Gold and other real assets gaining favor as inflation hedges
• Lower currency hedging costs making international bonds more attractive
• A weaker dollar driving up commodity prices – offering an entry point for commodity exposure

Additional Ideas: 

Diversifying bond exposure: A softer dollar has lowered the currency hedging cost for international investors in U.S. bonds. On a hedged, like-for-like basis, German 10-year bunds now offer more attractive yields than their hedged U.S. counterparts.

Commodities as diversifier and inflation hedge: A weaker dollar also tends to boost commodity prices. Gold, in particular, is experiencing one of its strongest years on record. Since 1973, it has now outperformed both U.S. Treasuries and equities. This underscores the importance of diversifying into real assets as the macro environment shifts.