doi.org/10.71734/DP‑2026‑34

Why did the US dollar depreciate and long-term US Treasury yields rise after the April 2025 U.S. tariff announcements even though markets clearly moved into “risk-off” mode? We address this puzzle using high-frequency asset price data and a flexible econometric approach that exploits changes in volatility to let the data themselves speak about the mechanisms at work. Our findings show that the episode cannot be understood as the effect of a single tariff shock. Rather, it reflects the interaction of safe-haven demand, confidence in U.S. institutions, Treasury-market intermediation, and changes in the convenience value of dollar-denominated safe assets. This combination helps explain why the dollar weakened in spite of an initial flight to safety.

A tariff shock unlike previous tariff shocks

We study the financial market impact of the US tariff announcement made on 2 April 2025. The US Administration imposed tariffs on almost all trading partners, including a 10 % baseline tariff on imports from 180 countries and an additional “reciprocal” component linked to bilateral trade imbalances.

On the day of the announcement, markets behaved as we would expect in a global risk-off episode: equity prices fell, volatility spiked, and investors sought safety. However, in the days that followed, two features stood out: the US dollar depreciated against the euro, while long-term US Treasury yields rose.

This pattern is at odds with both standard safe haven behavior and canonical open economy trade theory. In typical global risk episodes, higher risk premia result in a stronger dollar and lower US yields as investors rush into dollar-denominated safe assets. Furthermore, in dominant currency models of trade, tariffs imposed by a country like the United States tend to appreciate its currency via expenditure switching.

Earlier US tariff episodes, such as the 2018‑2019 trade war, fit these predictions: they were associated with dollar appreciation and compressed term spreads. The 2025 episode, however, did not. We therefore question whether the April 2025 market reaction can be explained by a single “tariff shock,” or whether it reflects the interaction of multiple, distinct financial shocks.

Two key shocks: safe haven and U.S. Institutional Credibility

The heteroskedastic VAR model statistically identifies a set of structural shocks. We focus on the two that are most relevant for the “Liberation Day” episode. The first is a safe haven shock that captures a conventional global risk-off event. In response to such a shock, equity prices fall together with yields on long-term US Treasury yields. At the same time, the dollar appreciates against the euro as demand increases for US safe assets in response to a rise in market volatility.

The second shock has a very different dynamic pattern and is crucial for understanding the post-announcement dynamics. US long-term Treasury yields rise and the exchange rate depreciates against the euro. We interpret this as a deterioration in confidence in the institutional and policy environment underpinning the international role of the United States and label it as a US Institutional Credibility shock.

How these shocks explain the “Liberation Day” and why 2019 was different

We use historical decompositions to quantify how much each shock contributed to the observed movements in asset prices around April 2025 and, for comparison, around the August 2019 tariff escalation. In the case of the April 2025 event, we find that the safe haven shock explains most of the fall in equity prices and the spike in volatility. The episode initially looks like a standard global risk-off event.

In the subsequent days, the unusual combination of a weaker dollar and higher long-term US yields are driven primarily by the US Institutional Credibility shock. This shock becomes dominant after the initial market reaction, accounting for the persistent depreciation of the dollar and the widening of the US term spread.

In the case of the August 2019 tariff escalation, by contrast, we find that this episode is largely explained by shocks with a safe haven profile and that the US Institutional Credibility shock plays a minor role. Term spreads compress and the dollar behaves in the same way as during a typical safe haven episode, in line with earlier findings on trade war episodes.

This comparison shows that April 2025 was not just a “bigger 2019.” Rather, it activated an additional mechanism: a rise in Treasury risk premia that weakened the dollar and raised long-term yields, on top of the initial risk-off response.

Ter Steege, L., S. Velasco (2026), What volatility reveals: Agnostic identification of exchange rate and treasury-market dynamics in inconvenient times, Bundesbank Discussion Paper, No 34/2026