High bond yields and a strong dollar could be here for longer, as policy conditions mirror the 1980s, Bank of America says

• The mix of loose fiscal policy and tight monetary policy looks similar to the 1980s, BofA said.
• In that decade, those circumstances led to high yields and a strong dollar, similar to what's occurring today.

The recent spike in Treasury yields and the dollar's exceptional strength may point to trends that are here to stay, Bank of America said in a Thursday note.

That's if history is any indication.

In tracing the market's past patterns, the report notes that recent fiscal and monetary policy have both moved similarly to the 1980s. Specifically, stimulus from the pandemic, followed by sudden Federal Reserve hawkishness, is in line with trends seen 40 years ago.

"We note that this was also the case when Reaganomics led to loose fiscal policy and Volcker tightened monetary policy in the early 1980s, leading to both high yields and a strong USD," BofA wrote. "We are not suggesting that rates and FX will go back to the levels seen in the 1980s, but the market reaction to a similar policy mix is consistent."

Now, long-term yields could stabilize well above recent levels, and potentially reach higher in certain scenarios. The risk of further upside also comes as globalization — a theme that has helped yields decline in recent decades — appears to be dwindling, if not altogether reversing, BofA said.

As high yields have generally corresponded with a strong dollar, the greenback will remain historically strong, even if inflation is tamed and interest rates reverse course. The yield-dollar correlation might only break if the Fed gives up its inflation fight, or if the inflation target rate is moved.

The exceptionalism of US assets has also been a boon for the dollar, as strong foreign flows into both bond and equity markets have helped the US Dollar Index rise 2.2% since the year's start.

Further projections of what happens next, however, will largely be determined by future economic conditions in the US, the report said.

BofA continues to forecast a non-landing scenario for the economy, which would support both high yields and a strong dollar. This would also be the outcome in the case of a recession and sticky inflation.

But if a soft landing occurs, or a recession in a deflationary environment, the US dollar and yields would come down, though on different time frames.

Still, post-landing, investors can expect the greenback and bond yields to remain historically high, even if lowered from today's levels. After all, US exceptionalism and a continuing turnabout in globalization trends should support this.

"However, we would also flag a post-landing scenario that would be negative for the USD despite higher yields. This is a case of markets getting concerned about US debt sustainability, both weakening the USD and increasing yields," Bofa added.