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I was reading this Fortune article (http://fortune.com/2016/11/14/donald-trump-victory-dollar-inflation/) and came across this confusing quote:

"'Clearly the market has settled on a 'buy dollar' theme on the basis there will be a debt-fueled U.S. fiscal binge that will push up inflation,' TD Securities European Head of Currency Strategy Ned Rumpeltin said.

and the start of the article says that "the risk of faster inflation and wider budget deficits...sent Treasury and other benchmark global yields shooting higher."

Why would this be the case? Shouldn't it be the opposite (higher inflation-->less valuable dollar)? Or are markets anticipating the Fed to more aggressively raise the interest rate?

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  • $\begingroup$ If there is a perceived risk of higher inflation then existing bonds become less valuable. The only way they can be sold is to reduce their price but if you buy a bond at a reduced price then the coupon payments as a fraction of the price paid for the bond is now higher - i.e. a higher yield. $\endgroup$
    – Mick
    Commented Apr 19, 2017 at 7:53

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Unless I'm misreading you, your question seems to imply that higher treasury yields are intuitively associated with lower inflation. they are not. Higher yields are associated with fear of higher inflation. Consider the following:

  1. Treasury securities pay out a fixed amount at maturity.
  2. Investors fear inflation between now and when the securities mature because the inflation makes the payout worth less in real terms.
  3. Investors will therefore pay less for these securities today. Prices of the treasury securities therefore fall today.
  4. "Falling prices" is the same thing as "increasing yields." Heuristically, Yield = Payout/Price -1. The payout is fixed.

Summary: The fear of future inflation causes treasury yields to rise today.

Wider deficits also lead to higher yields because the supply of treasuries increases. This will lower the price of treasuries, which is the same as increasing yields.

Now, why is the market buying dollars? The market is anticipating US consumers and government going into debt and driving up interest rates. In order to take advantage of these higher interest rates, one must have to have dollars to lend. But no, foreigners are not buying dollars because they are anticipating inflation...they are buying because they anticipate higher (real) interest rates. The inflation will come as a side effect of the anticipated spending spree and foreigners are expecting the inflation to be smaller than the rise in nominal interest rates.

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My interpretation of the argument is that real GDP is also supposed to rise, not just inflation. Increased growth makes US dollar assets more attractive, hence drawing portfolio inflows. The rise in inflation is a side-effect of the scenario, and not the cause.

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