US Dollar: Downside risks grow as yields contained – MUFG

MUFG’s Derek Halpenny and Abdul-Ahad Lockhart highlight that the US Treasury’s unscheduled expansion of long-end buybacks triggered the largest daily US Dollar drop since March outside intervention episodes. They argue the move underscores growing concern over US yield levels, could undermine confidence in US assets, and leaves the Dollar more vulnerable on the downside even if yields are contained.

Treasury buybacks weigh on Dollar

"The US Treasury unscheduled announcement yesterday that it would increase US Treasury bond buybacks resulted in the biggest daily drop for the US dollar since March when you exclude the two episodes of USD selling intervention in April/May and July. The buyback announcement could more than double the total from the original plan of a “maximum” of USD 2bn to “at least” USD 4bn and will be focused on 10-year and longer."

"Well, if Scott Bessent really believes that then the US Treasury could play a key role here by of course addressing the ever-expending fiscal deficit with fiscal consolidation. We all know that’s not going to happen and hence the danger now following this announcement (and the FIMA report comment to Japan following intervention) is that it proves counter-productive and leads to reduced appetite for either holding US assets (UST bond sales) or reduced appetite for exposure to the US dollar (dollar selling) or both. Even if the Treasury buy-back plan does contain yields, the US dollar now remains more vulnerable to the downside on the fact that yields are potentially lower."

"What this buyback announcement does mean is that the Jackson Hole speech next week by Fed Chair Warsh has now become more important. There is no hiding the fact that the latest move higher in yields was triggered by the FOMC and Warsh’s press conference."

"Finally, we should also not ignore the prospect of inflation continuing to subside – that would be an important fundamental backdrop for helping contain yields. That could ease credibility risks related this announcement but of course then the markets would likely remove the tightening currently priced which would also weigh on US dollar performance. There appears to now be more avenues opening for US dollar weakness ahead rather than dollar strength."