Over the past few months, we have been seeing some very odd things going on in the bond and currency markets – or perhaps it would be more appropriate to say that there are things going on that never would have occurred only a few years ago.
One of the most notable things that occurred started back in September, when the Federal Reserve (the central bank of the United States and steward of the U.S. dollar currency) started to lower its benchmark interest rate. Over the period that ran from September 18, 2024, through the end of 2024, the Federal Reserve reduced the federal funds target rate (the rate at which American commercial banks lend to each other on an overnight basis) by a total of 100 basis points. This reduced the effective federal funds rate from 5.33% last summer to 4.33% today:
The exact reasons for the reductions in the federal funds rate are only known to the Federal Reserve and the members of the Federal Open Market Committee. There have been some analysts who speculated that the central bank was trying to reduce mortgage rates heading into the U.S. election in an attempt to assist the incumbent party. This would suggest that the Federal Reserve was engaging in political activities, which would be a violation of its stated neutrality policy, but it would not be the first time that the central bank has engaged in such political posturing.
Other analysts and market commentators suggest that the Federal Reserve was attempting to normalize monetary policy following its actions to fight inflation in 2022 and 2023. This explanation might work to explain the 50-basis point cut in September 2024, but it does not explain the November 2024 and December 2024 cuts. This chart shows the reported headline inflation rate calculated using the year-over-year change of the Consumer Price Index for All Urban Consumers:
As we can see, the headline inflation rate was actually steadily declining over the April 2024 to September 2024 period. Each month during that period saw the annual rate of change in the Consumer Price Index for All Urban Consumers decline compared to the preceding month. Thus, it might be possible to make a case that the September 2024 interest rate cut was indeed due to the central bank no longer needing to combat inflation as aggressively as before. However, we can then see that the headline inflation rate, as measured using the exact same metrics, started to get worse. The reported inflation rate increased during every single month over the September 2024 to January 2025 period. If inflation was getting worse, why the Federal Reserve still cutting rates? The reasoning simply does not add up. Furthermore, why has the Federal Reserve not reduced rates yet in 2025 despite an improving outlook for inflation? This, unfortunately, suggests that the rate cuts in 2024 may indeed have been politically motivated, as the Federal Reserve may have been trying to get interest rates down in an attempt to help defeat Donald Trump in the election (who is a known critic of Federal Reserve Chairman Powell and stated that he intends to replace Jerome Powell should he get elected).
In the past, interest rate cuts by the Federal Reserve would have lowered the interest rates on investment-grade (and junk) bonds. Indeed, I cannot begin to count the number of articles that I saw posted to Seeking Alpha, TalkMarkets, and other financial sites suggesting that investors “buy bonds” over the summer of 2024 in anticipation of the Federal Reserve’s interest rate cuts. Unfortunately, this actually proved to be the wrong move, as bond prices started to fall in response to the interest rate cuts. The date that the Federal Reserve announced the first of its interest rate cuts in 2024 was September 18, 2024. This chart shows the performance of the Bloomberg U.S. Aggregate Bond Index (AGG) from that date through the end of 2024:
The Bloomberg U.S. Aggregate Bond Index tracks the price of investment-grade U.S. dollar-denominated bonds issued by governments and corporations within the United States. As we can see, the interest rate cuts actually had the effect of making bond yields rise. Basically, the central bank reduced interest rates only to steepen the yield curve and cause interest rates on most longer-term debt to rise! This makes sense given that inflation also started to rise immediately following the first interest rate cut, and it also suggests that the Federal Reserve made a mistake by cutting interest rates.
Two more strange events occurred following the United States imposing tariffs on imported goods from most of its trading partners on April 2, 2025. One of these is that the U.S. dollar index (DXY), which measures the value of the U.S. dollar against a basket of six foreign currencies – euros, Japanese yen, Canadian dollars, British pounds, Swedish kroner, and Swiss francs – declined. This chart shows the U.S. dollar index from April 2, 2025, through today:
This represents the continuation of a trend that we have seen all year. Here is the year-to-date chart for the U.S. dollar index:
This is the exact opposite of what we would expect following the imposition of tariffs. According to Investopedia:
The relative values of currencies are influenced by the demand for them, and that demand is influenced by trade. If a country exports more than it imports (known as a trade surplus), there is a high demand for its goods, and thus, for its currency. The economics of supply and demand dictate that when demand is high, prices rise and the currency appreciates in value.
In contrast, if a country imports more than it exports (known as a trade deficit), there is relatively less demand for its currency, so prices should decline. In the case of currency, it depreciates or loses value.
In most cases, tariffs cause a country’s imports to decline relative to its exports. Thus, they bring it closer to a trade surplus than the country was prior to the imposition of the tariffs. This should, ordinarily, cause the country’s currency to rise against foreign currencies. However, as we can see from the U.S. dollar index, this did not occur when the U.S. imposed its tariffs on the rest of the world back in April 2025.
A second odd thing that occurred following the imposition of the tariffs is that bond prices fell. This chart shows the Bloomberg U.S. Aggregate Bond Index from April 2, 2025, through today:
As we can all remember, the S&P 500 Index (SP500) fell precipitously in the days after the tariffs were imposed. That makes sense, given that the announced tariffs were a lot higher than what most analysts and market watchers expected, and investors were very uncertain about the impact that they would have on global trade and corporate earnings. Ordinarily, this would have caused investors to flee into bonds for safety. That would have pushed up bond prices and pushed down bond yields. As we can see from the chart above, the exact opposite happened and investors basically decided that both stocks and U.S. dollar-denominated bonds were too risky to hold. That is not at all usual, and it is certainly not usual when investors begin to anticipate a recession (JPMorgan was putting the odds of a U.S. recession occurring in 2025 at over 50%).
The only explanation that I can think of to explain this is that global investors are beginning to doubt the ability of the U.S. dollar to act as a store of value. Basically, investors believe that some form of currency devaluation will occur in the future, and it will probably come from the Federal Reserve instituting some form of “yield-curve control” in which it purchases long-dated bonds with newly printed money. This scenario would result in bond investors getting repaid with a currency that is worth far less than what they originally lent to the issuing institution. It is worth noting that this could also explain the surge in precious metals prices year-to-date:
This chart shows the spot prices of gold (black line), silver (blue line), and platinum (orange line) year-to-date. As we can see, the prices of all three metals are up substantially year-to-date and are clearly trending higher. This seems to confirm my suspicions that global investors have lost faith in the U.S. dollar as a currency and are rushing into precious metals in an attempt to preserve the purchasing power of their assets. We will discuss this further at a later date.