Reminiscent of the ‘Greenspan conundrum’, since 18 September 2024 the Federal Reserve has cut short-term interest rates by 100 basis points, while 10-year interest rates have risen by 100 basis points, defying conventional expectations. This column argues that this ‘reverse conundrum’ can be explained by a sharp decline in foreign official demand for US Treasuries and a likely shift towards gold, which is less vulnerable to sanctions and asset freezes.
Professor Johns Hopkins University
The Federal Reserve has cut interest rates 100 basis points since the 18 September 2024 Federal Open Market Committee (FOMC) meeting, but the 10-year nominal yield on US Treasuries is up 100 basis points over the same period – a Greenspan conundrum in reverse that we term the ‘reverse conundrum’ (Figure 1). Researchers and commentators have attributed this to fear of tariffs and inflation (Bloomberg 2025), concerns about debt sustainability (Reuters 2025), or upgrades to growth expectations (Klein 2025). However, the rise in 10-year yields mostly came in the form of increasing real yields and term premia, rather than an increase in inflation expectations (Figure 2). Meanwhile, the US dollar is sharply appreciating alongside rising yields, which is not consistent with debt sustainability concerns. In this column, we present an alternative interpretation of the reverse conundrum based on our recent research (Ahmed and Rebucci 2024), suggesting that it may also reflect waning foreign official demand for dollar-denominated safe assets, possibly driven by geopolitical concerns including fear of sanctions and asset freezes.
Figure 1 Federal Funds Rate and nominal 10-year US Treasury yields (%)
Notes: The figure plots the daily federal funds effective rate and the nominal 10-year US Treasury yield. The first vertical dashed line is 18 September 2024 (Sep FOMC). The second vertical dashed line is 6 November 2024 (US elections)
Source: FRED and authors’ calculations.
The rise in 10-year yields coincides with a substantial reduction in dollar reserve assets held by foreign official institutions. The left panel of Figure 2 shows that real 10-year yields rose 70 basis points, making up most of the jump since 18 September 2024. The 10-year term premium increased by a similar magnitude. The right panel reports foreign official dollar reserves custodied at the Fed. Dollar reserves are the sum of foreign official holdings of US Treasuries and reverse repos via the foreign repo pool. 1
Figure 2 Real 10-year US Treasury yields and term premia, and foreign official dollar reserves
Notes: The left panel plots the daily real 10-year US Treasury yield (TIPS) and the Kim and Wright (2005) 10-year US Treasury term premium estimate. The right panel plots the weekly average of foreign official dollar reserves custodied at the Federal Reserve. The first vertical dashed line is 18 September 2024 (Sep FOMC). The second vertical dashed line is 6 November 2024 (US elections)
Source: FRED, Fed H.4.1, and authors’ calculations.
The decline in foreign official dollar reserves beginning in September aligns precisely with the reversal in 10-year yields. Since the September FOMC meeting, foreign official institutions reduced their dollar reserves by $113 billion. At the same time, nominal and real 10-year yields rose by 70 and 100 basis points, respectively. While not conclusive, this opens the possibility that dollar reserve sales are putting upward pressure on long-term interest rates. Indeed, the size of these movements in reserves and yields match the price impact estimates from our recent paper (Ahmed and Rebucci 2024).
We separate foreign official dollar reserves into US Treasuries holdings and foreign repo deposits in Figure 3. The initial decline in dollar reserves beginning on 18 September was driven by a reduction in the foreign repo pool (right panel). However, after the November 6 presidential elections, foreign officials switched to selling US Treasuries at an accelerated pace (Figure 3 left panel). Foreign officials sold about $78 billion US Treasuries since 6 November, with their total holdings falling below $2.87 trillion as of 8 January. According to data from the NY Fed, these sales bring foreign official holdings of US Treasuries to its lowest level since March 2020, when US Treasury markets froze (Vissing-Jorgenson 2021, He et al. 2022). Importantly, we can see that the proceeds from US Treasury sales are not reallocating to the foreign repo pool or vice versa. This suggests that foreign officials are reducing their allocation to US dollar denominated assets.
Figure 3 Foreign official holdings of US Treasury securities and reverse repos at the NY Fed
Notes: The left panel plots the weekly average of foreign official US Treasury holdings. The right panel plots the weekly average of foreign official deposits in reverse repos custodied at the Fed. The first vertical dashed line is 18 September 2024 (Sep FOMC). The second vertical dashed line is 6 November 2024 (US elections).
Source: Fed H.4.1, and authors’ calculations
If foreign officials are selling large quantities of dollar reserves, then two questions naturally follow. First, which counterparties are stepping in to buy these dollar assets? Second, which assets are foreign officials reallocating towards? Figure 4 suggests that the main counterparties to foreign official sales of US Treasuries are US dealer banks, stepping in to purchase the additional supply of US Treasuries not picked up by the other investors. Dealer net holdings of US Treasuries reached all-time highs, rising more than $70 billion since the 6 November elections, closely matching the $78 billion US Treasuries sold by foreign officials over the same period. Over-extended dealer positioning suggests that other structural US Treasury investor segments – domestic and foreign private investors in particular – are not stepping in. Moreover, the Federal Reserve continues running off the USTs on its balance sheet. Consequently, foreign official sales met by weak appetite for US Treasuries from other investors, combined with constrained absorption by dealers helps to explain why real 10-year Treasury yields and term premia are rising as sharply as they are, as we argue in Ahmed and Rebucci (2024) and as highlighted in Duffie (2023).
Figure 4 US Treasury coupon securities held by the Federal Reserve and by dealer banks
Notes: The left panel plots weekly average of US Treasury securities excluding T-bills held on the Federal Reserve balance sheet. The right panel plots weekly dealer net positions of US Treasury securities excluding T-bills. First vertical dashed line is 18 September 2024 (Sep FOMC). The second vertical dashed line is 6 November 2024 (US elections).
Source: Fed H.4.1, New York Fed and authors’ calculations.
Lastly, if foreign officials are reducing their holdings of dollar reserves, what are they reallocating toward? Outside the US, bond prices are falling and currencies are depreciating in the UK, Canada, and Japan, suggesting that it is less likely that foreign officials are reallocating from dollar assets to other fiat-currency reserve assets. Figure 5 suggests that foreign officials may be reallocating towards gold as a reserve asset.
Figure 5 Cumulative returns of gold and their timing (US versus non-US market hours)
Notes: The left-panel plots daily cumulative gold log returns since 1 January 2024. The right-panel separates cumulative gold log returns into US and non-US market hours. Log returns are defined as log-differenced daily gold prices. The first vertical dashed line is 18 September 2024 (Sep FOMC). The second vertical dashed line is 6 November 2024 (US elections).
Source: Authors’ calculations.
Figure 5 shows that gold prices appreciated nearly 30% over the last year. Despite a sharp rise in real yields and US dollar appreciation, global gold prices, which are priced in dollars, did not decline since the September FOMC. In fact, gold prices continued to appreciate, particularly during non-US hours, which may indicate robust foreign demand for gold from countries such as China. The right panel of Figure 5 illustrates this by decomposing gold returns into those realised during US market hours (i.e. 9:30AM-16:00 EST) and non-US market hours.
While the jury is still out there as to whether geopolitical risk and fear of sanctions and asset freezes are undermining the US dollar’s status as the dominant reserve currency (e.g. McCauley et al. 2024, Brunnermeier et al. 2022, Folkerts-Laundu et al. 2022), it is possible for even a small reduction in the US dollar share of foreign reserves to have a significant short-run impact on US Treasury markets, as we initially claimed in Ahmed and Rebucci (2022).
Source: cepr.org