Multiple distinct shocks drove 2025 dollar drop and yield rise
The market aftermath of the April 2025 U.S. tariff announcement was driven by multiple distinct shocks rather than a single trade disturbance, according to a Banco de España study. Institutional credibility losses explained the concurrent dollar drop and Treasury yield rise.
Decomposing the safe-haven puzzle
Authors Lucas ter Steege and Sofia Velasco analyzed daily financial market data from July 2007 to May 2025 using a vector autoregression with stochastic volatility and Student-t distributed errors.
The empirical model decomposes the market fallout from the April 2, 2025 tariff package into orthogonal structural components.
While a conventional safe-haven shock accounted for the immediate decline in equity prices and elevated volatility, it failed to explain why the dollar depreciated against the euro while ten-year U.S. Treasury yields rose.
The decomposition reveals that an institutional credibility shock generated nearly all the currency depreciation and higher term premia, while a Treasury intermediation shock caused swap spreads to widen and convenience yields to fall.
Diverging dimensions of exorbitant privilege
The findings highlight structural changes in U.S. exorbitant privilege since the 2008 global financial crisis.
Post-crisis balance-sheet regulations constrained dealer intermediation capacity, causing ten-year dollar convenience yields and Treasury convenience yields to decouple.
While the August 2019 tariff escalation conformed to canonical flight-to-safety dynamics with lower bond yields, the 2025 episode exposed independent vulnerabilities in sovereign debt intermediation and institutional confidence.
Exorbitant privilege is no monolith
The paper convincingly dismantles the claim that trade policy alone dictated the 2025 market turmoil.
By separating dealer bottlenecks from institutional trust, the methodology provides a vital toolkit for sovereign debt analysis.
Central banks can no longer assume that global uncertainty automatically anchors demand for U.S. assets.