Until proven otherwise, I will view the recent backup in U.S. market yields as indicating the emergence of important new global market dynamics. For much of the past year, the dollar benefited from various facets of a short-covering rally. This dollar strength reinforced the perception of U.S. Treasury and agency securities as premier global safe haven assets. Global financial crisis buoyed the dollar, albeit temporarily. U.S. market yields collapsed, bolstering the view in Washington and throughout the markets that U.S. policymakers retained virtually unlimited flexibility.

The belief in a renewed King Dollar, in combination with what appeared powerful global deflationary forces, had most convinced that inflation risk had been taken completely out of the equation. But after trading to almost 90 in early March, the dollar index again dropped back below 80. The combination of double-digit (as % of GDP) U.S. federal deficits, massive Federal Reserve “quantitative ease,” and renewed dollar weakness granted virtually unlimited flexibility to policymakers around the globe. China, the U.S. and Europe were on the forefront of unprecedented synchronized global monetary and fiscal stimulus. Government finance Bubble and global reflation dynamics quickly emerged.

Global reflation has the markets reexamining early held views. For one, the dollar has become much less appealing, both as a safe haven vehicle and as a longer-term store of value. To be sure, the U.S. is these days a fiscal blackhole. Moreover, global reflation is typically more constructive for the “emerging” and “commodity” economies. And the greater the flows from the “Core” (U.S.) to the “Periphery” the more incentive there is to diversify out of the devaluing dollar. The greater the relative outperformance of non-dollar asset-classes - the greater the self-reinforcing speculative flows available to fuel global reflation. Meanwhile, the combination of a weaker dollar and the emerging global reflationary scenario dramatically alter the prospective U.S. inflationary backdrop. Crude prices have more than doubled from February lows.

The rejuvenated dollar from a few months back appeared to assure great leeway to the Bernanke Fed. The expectation was that the Fed essentially had unlimited capacity to employ “quantitative easing.” This bolstered the market’s generally sanguine view of the yield impact from the Treasury’s massive funding requirements. Especially with the announcement of huge ongoing MBS purchases, the view solidified that the Fed would essentially peg long-term market yields - as it does short-term borrowing rates. And, importantly, the perception that the Fed could set artificially low long-term interest rates – hence Treasury funding costs – worked to bolster a more optimistic reading of the U.S. fiscal position (not to mention the U.S. household balance sheet).

Yet a much more uncertain world is emerging. Global reflation and international markets are – as inflation and market dynamics tend to do - taking on a life of their own. And just as Credit Bubble dynamics overwhelmed Greenspan rate tinkering back in 2004/05, there are now strong countervailing market forces working against the efficacy of Bernanke helicopter money. If global reflation takes hold simultaneous with a weakening dollar, inflation could easily emerge as a major threat here in the U.S. And if global markets begin determining longer-term U.S. Treasury and MBS yields – as opposed to the Bernanke Fed manipulating them artificially low – the U.S. recovery outlook becomes greatly more clouded.

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.