Good morning. The selloff in global bond markets is intensifying this morning, pushing yields to their highest levels in decades and weighing on risk appetite across the financial system. Ten-year Treasury yields are holding near the 5% mark, equity futures are pointing to losses at the open, and the dollar is advancing incrementally against all of its G10 counterparts.

After a brief reversal yesterday, energy prices are climbing once again, with benchmark Brent crude futures trading above $105 a barrel as buyers scramble to secure supplies amid a deepening shortfall. The Middle East’s biggest energy exporter, Saudi Arabia, is under attack from three directions at once: Iran continues to launch drones and missiles; groups in Iraq have knocked the critical East-West pipeline offline; and Houthi militants in Yemen are striking airbases and threatening to choke shipping through the Red Sea. Flows through the Strait of Hormuz remain far below their pre-war levels, and Ukrainian attacks on Russian energy infrastructure are deepening global shortages—particularly refined products—adding to upward pressure on price expectations across most major economies.

With inflation risks mounting, policy rate expectations are soaring. The Federal Reserve is expected to raise rates tomorrow—its first increase since 2023—and to follow with the equivalent of three more by next September. The Bank of Japan is seen lifting its rate to a 31-year high this week and then moving at least twice more over the same period; the European Central Bank and the Bank of England are each expected to tighten at least four times, and the Bank of Canada five.

From a relative carry standpoint, interest differentials have not shifted dramatically. As expectations have climbed in near-lockstep across the big advanced economies, the DXY-weighted two-year rate gap has narrowed but remains less dollar-supportive than it was earlier in the year, and the greenback’s advance has been relatively modest.

We think the “American exceptionalism” trade will keep fading over the next year, but a serious deterioration in global risk appetite could yet revive safe-haven flows and bring the ‘dollar smile’ back to life. Under the ‘smile’ theory, originally advanced by Morgan Stanley’s Stephen Jen, the US dollar tends to strengthen both when the US economy is significantly outperforming or when global conditions are dire, but weakens in the middle when growth is moderate and unremarkable.​​​​​​​​​​​​​​​​ Before 2025, sharp jumps in implied stock market volatility—as measured using the VIX, Wall Street’s “fear gauge”—typically triggered corresponding jumps in the dollar. That relationship broke down in 2025 after the ‘Liberation Day’ tariff debacle, and has remained weaker since.

We don’t know how much of the dollar’s “safe haven” role has been ceded to the Swiss franc and euro, or whether currency hedging flows from foreign holders of US assets could rebound in a true risk-off shock. But we suspect the old reflexes are not entirely gone. For hedgers, the implications are twofold: don’t treat high-beta and emerging-market currencies as though rate differentials and fundamentals alone will drive them—and consider taking out protection against sudden moves in case the dollar starts smiling once again.