BCA Research Recommends Selling US Dollar, Cites Waning Inflows and Yield Dynamics

BCA Research is advising investors to sell the U.S. dollar, anticipating a decline in U.S. real interest rates and a slowdown in foreign portfolio inflows. The firm recommends rotating into a basket of currencies supported by strong current account surpluses, including the South Korean won, Japanese yen, New Taiwan dollar, Singapore dollar, and the euro.

The Case Against the Dollar

BCA's bearish outlook on the dollar is partly based on its expectation that U.S. "core real yields" will fall. The firm defines this metric as the yield on Treasury Inflation-Protected Securities (TIPS) after stripping out the bond term premium. According to BCA, the recent rise in Treasury yields has been driven by higher term premiums related to fiscal and inflation risks, not by improved economic growth prospects. Higher term premiums typically weigh on the dollar, whereas rising core real yields tend to support it.

Furthermore, the research firm highlights a potential weakening of foreign investment flows that have recently propped up the greenback. A surge in foreign buying of U.S. stocks, driven by enthusiasm for artificial intelligence, helped finance the large U.S. current account deficit. BCA warns that these inflows could slow if a correction occurs in what it views as overvalued U.S. technology stocks.

As a result, BCA suggests the U.S. dollar may become more sensitive to global economic growth and could weaken in tandem with a decline in the U.S. stock market. In contrast, the euro may exhibit more defensive characteristics as European investors potentially repatriate a larger portion of their current account surplus instead of recycling it into U.S. securities.

Recommended Positions and Outlook

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BCA states that it currently holds long positions in the South Korean won, Japanese yen, and New Taiwan dollar against the U.S. dollar. The firm is also using the Hungarian forint as a proxy for exposure to the euro. The common theme among these recommended currencies is their backing by strong current account surpluses, which BCA expects will provide support as international investors reduce their exposure to U.S. assets.

While the firm also expects the Chinese yuan to appreciate against the dollar, it believes Chinese authorities will intervene to limit the currency's gains. This could cause the yuan to underperform other currencies with current account surpluses. Conversely, BCA anticipates that the Brazilian real, Indonesian rupiah, and Philippine peso will lag, making them less attractive alternatives to the dollar.

Broader Market Implications

A weaker U.S. dollar has significant implications for other asset classes. Based on its currency outlook, BCA Research recommends the following asset allocation adjustments:

• Equities: Underweight U.S. stocks, which are expected to underperform global markets. The firm maintains a neutral stance on emerging markets, a small overweight on Europe, and a large overweight on Japan.
• Commodities: A falling dollar is seen as a tailwind for gold and gold mining stocks.
• Bonds: Non-U.S. government bonds are viewed as an attractive opportunity following any short-term pullbacks.