The erosion of the safe-asset status of US Treasuries in the tariff war
In this paper, Viral V. Acharya and Toomas Laarits analyze how the April 2025 “Liberation Day” tariff shock, affected the safe-asset status of US Treasuries through changes in convenience yields and stock-bond covariance.
The authors decompose Treasury yields into three components—a frictionless risk-free rate, credit spread (via CDS), and convenience yield—to isolate how convenience yields behaved during the April 2025 tariff shock. They measure convenience yields using the TIPS–Treasury premium at 2, 5, and 10-year maturities. Stock–bond covariance is estimated using both daily data (30-trading-day rolling windows from 2005–2024) and a novel intraday approach with 5-minute ETF returns during the February–October 2025 event window, allowing them to isolate movements on specific tariff-announcement days. They supplement this with Treasury International Capital flow data, alternative safe-asset covariance (gold and USD), and inflation expectations measures over the same 2025 period.
Findings
Stock-bond covariance turned positive on key tariff days
- On April 3–4 and 7–8, Treasuries exhibited strong negative covariance with equities (annualized covariance reached −10%), consistent with safe-haven behavior.
- On April 9, 11, and 23 (major tariff announcement days), covariance turned sharply positive (up to +5% annualized), meaning Treasuries behaved like risk assets.
- April 23 registered one of the highest positive stock-bond covariances in 5,000+ trading days since 2005.
- Intraday correlation peaked at +0.5 on April 11 and 23, vs. historical flight-to-safety episodes (GFC, COVID) where correlation approached −1.
Long-Term Convenience Yields Collapsed; Short-Term Rose
- 10-year TIPS-Treasury premium fell nearly 10 basis points from end-March to April 10 trough, turning negative for the first time since 2005.
2-year and 5-year premiums rose by over 10 bps, creating unprecedented term-structure divergence. - Average gap between 2Y and 10Y convenience yields widened by 7 bps in April 2025 vs. 2 bps historically.
- The 5Y–10Y gap opening (>15 bps in one week) ranked in the top 10 of 1,000+ weeks of data.
Loss of hedging property explains convenience yield drop
- Stock-bond covariance due to convenience yield component turned positive for 10Y bonds in April 2025 (reached +0.6), vs. persistently negative in 2005–2024. For 2Y and 5Y bonds, convenience-yield covariance remained negative (safe-haven property intact).
- Counterfactual calculation: If 10Y bonds had retained their historical hedging property (matching the 5Y pattern), convenience yield would have been 12 bps higher in April.
- The frictionless rate component provided most of the hedge at the long end; the convenience yield component became a risk factor.
Inflation expectations showed only modest nicreases
- 2-year expected inflation (Cleveland Fed) rose by 36 bps, implying only a 7 bps impact on convenience yield slope via regression model, while 5Y and 10Y expected inflation rose just 13 bps and 5 bps, respectively. Breakeven inflation from TIPS curves actually declined in April at some maturities.
- Inflation fears alone cannot explain the 10 bp drop in long-term convenience yields.
Foreign investors withdrew; gold emerged as substitute
- April 2025: Net $47 billion outflow from long-term Treasuries, vs. typical $47 billion monthly inflow.
- Country-level patterns: Euro Area, Canada, and Total Asia sold Treasuries contrary to their usual safe-haven buying; only UK bought ($40B).
- Gold rotation: On days when Treasuries showed positive covariance with stocks, gold showed negative covariance (hedge behavior); strong negative relationship (scatter plot correlation). Gold futures appreciated >30% from April to October 2025 as alternative safe asset.
- US dollar (DXY): Did not exhibit consistent safe-haven pattern (only on April 3), in stark contrast to GFC, Eurozone crisis, and COVID.
Tariff War Shock and the Convenience Yield of US Treasuries -A Hedging Perspective
Authors: Viral V. Acharya, Toomas Laarits
From: New York University
The dollar depreciation paradox: rising yields, falling demand for Treasuries
This paper, by Zhengyang Jiang, Arvind Krishnamurthy, Hanno Lustig, and Robert J. Richmond, documents how the April 2025 tariff announcements revealed an erosion of US Treasuries’ safe-asset status that had been building since 2023. Empirically, when the VIX spiked to 52, the dollar depreciated 6.5% against the euro (opposite of historical flight-to-safety patterns), while Treasury yields rose 48bp relative to German Bunds. More tellingly, the 1Y Treasury convenience yield turned negative in summer 2024 for the first time since 1988, and has remained depressed, signaling that foreign investors no longer pay a premium to hold long-term dollar assets.
Using a calibrated two-country model with bond-in-utility preferences and gross portfolio asymmetry, the authors compare steady states where the dollar retains vs. loses reserve status. The model is calibrated to 2016 US data: 150% of GDP in safe debt with 30% held by foreigners, and a 2% baseline convenience yield on Treasuries. In the reserve-currency loss scenario, foreign demand for dollar bonds disappears , forcing US investors to reabsorb $20+ trillion of bonds, which requires a 92bp rise in interest rates, a 92bp fall in convenience yields, and a 7.6% real dollar depreciation to close the trade deficit. The present value of lost “exorbitant privilege” (seigniorage from issuing the reserve asset) is estimated at $15–29 trillion (52–93% of GDP).
The paper shows that:
- Tariffs alone have minimal impact on asset prices if reserve status remains intact.
- The April 2025 asset-market anomalies, i.e. dollar depreciation amid a VIX spike, rising yields, and falling convenience yields, reflect perceived loss of reserve-currency status rather than tariff mechanics. Because convenience-yield erosion predates April 2025 by two years, the tariff shock punctuated rather than caused the trend.
- The model’s implications are stark: if the US loses reserve status, it faces structurally higher borrowing costs ( approximately 90bp), forced external rebalancing via dollar depreciation, and eventual closure of the trade deficit as seigniorage revenues disappear.
Dollar Erosion: Understanding the Loss of Reserve Currency Status
Authors: Zhengyang Jiang, Arvind Krishnamurthy, Hanno Lustig, Robert J. Richmond
From: Northwestern University, Stanford GSB, New York University
