Yield curve steepening weighs on the dollar

The U.S. Treasury curve has been in a bear steepener: both short- and long-term yields have risen, but the long end has climbed faster. The 30y–2y spread has widened to the highest level in almost four years after facing a deep inversion during part of 2022 and 2023, signalling a shift from recession worries toward expectations of firmer growth and stickier inflation.

The “bear” tag reflects the negative pressure on bond prices as investors demand a higher term premium to hold duration. The move has been fuelled by persistent inflation expectations, stronger nominal-growth narratives (especially because of the AI boom), a rebuild in term premium, and heavier Treasury issuance.

However, markets aren’t just reading the shape of the U.S. Treasury curve; they’re reading the politics behind it. The key question right now is whether recent moves around the Federal Reserve reflect an attempt to safeguard the institution’s independence—or to tilt it toward easier policy. The answer investors seem to be pricing is the latter, and it’s showing up unmistakably in the curve and the dollar.

What happened in bonds

Last week delivered a textbook steepening: front-end yields fell as traders leaned into the prospect of earlier/larger Fed cuts, while long-end yields rose on concerns that policy could become too loose, fanning future inflation risks and rebuilding a risk/term premium at the back end. In plain English: the short end priced policy relief; the long end demanded more compensation for uncertainty.

• Perceived pressure on Fed independence. Markets interpreted the headlines around reshaping the Fed’s leadership and the chatter about removing sitting officials as an effort to stack the Board with more dovish policymakers. The signal: a lower policy path than the economy might otherwise warrant.
• Inflation and institutional risk premia. If policy is expected to be looser, the long end embeds extra cushion for inflation uncertainty and institutional trust risk—both of which push yields higher at the back.
• Policy/legal noise around tariffs. Parallel legal questions over the scope of presidential tariff powers add another layer of uncertainty. Even without a near-term decision, that policy overhang nudges investors to demand more long-dated compensation—and seek hedges elsewhere.

FX impact: a softer dollar bias—with caveats

A steepening led by front-end down / back-end up typically leans USD-negative because carry erodes at the front end. Lower expected short rates trim the dollar’s carry advantage, especially versus cyclical or commodity-linked FX. Furthermore, a perceived drift away from Fed independence can sap institutional premium in the currency itself.

However, there are two caveats. If the backdrop turns risk-off, the dollar’s safe-haven role can still dominate, limiting downside or even lifting USD against higher-beta peers. And a steeper curve with higher real long-end yields can be USD-supportive on select crosses, especially low-yielders like JPY and CHF, even as the broad dollar softens.

There are several factors that could flip the USD narrative. First off, reaffirmed Fed independence. Clear guardrails—through appointments, communication, or legal clarity—could compress the institutional risk premium, supporting the dollar. Secondly, sticky inflation with credible policy restraint. If the Fed is seen holding the line even as inflation proves persistent, front-end could re-price higher, restoring some USD carry. And finally, hard-risk deterioration. A material risk-off shock would likely support USD despite a lower policy path.

Looking ahead, traders should watch out for developments in the FOMC voting structure and whether the dovish tilt materialises into a period of policy easing. Also, long-end term premium will be important to determine whether the steepening is being driven more by inflation expectations or pure risk premium.

US dollar index (DXY) vs. US 30year and 2year yield differential

Past performance is not a reliable indicator of future results.