Citigroup Slashes Short-Term Dollar Forecast, Citing Treasury Buybacks and Election Risk

Citigroup's foreign exchange strategy team has adopted a bearish short-term outlook on the U.S. dollar, citing an expected dovish shift from the Federal Reserve, political risks, and a U.S. Treasury plan to increase its purchases of government debt.

In a research note Thursday, strategists led by Daniel Tobon lowered their three-month forecast for the U.S. Dollar Index (DXY) to 98.34 from a previous target of 102.12. The downgrade follows a period in which the bank held a more neutral stance and comes after the dollar index fell to its lowest level since May on Wednesday.

Treasury Plan Seen as New Headwind

The primary new factor driving the revised forecast is the U.S. Treasury Department's recent announcement that it will double the size of its bond buyback program by November. The move is intended to lower long-term borrowing costs after recent 10-year and 30-year Treasury auctions saw the highest yields since the 2000s.

According to Citigroup, this policy creates a drag on the dollar through two main channels:

• It directly suppresses U.S. Treasury yields, reducing the dollar's relative interest rate appeal.
• It raises market concerns about financial repression, a policy where a government channels funds to itself that would otherwise go elsewhere in the economy.

Midterm Elections Amplify Caution

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Compounding the pressure on the dollar is the approaching U.S. midterm elections in November. The strategists noted that traders are already pricing out expectations for further Federal Reserve rate hikes, which had previously been a major source of dollar strength.

Looking ahead, the bank anticipates that investors will likely avoid taking long positions on the dollar before the election. The note cited "rising US political uncertainty and tail risks associated with a contested election" as reasons for caution.

Long-Term View and Potential Risks

Despite the short-term pessimism, Citigroup has not changed its long-term positive view on the dollar, which is underpinned by a belief that U.S. economic growth will outpace that of other G10 nations. The bank also raised its three-month forecast for the euro to $1.1750, citing expectations for a 25-basis-point rate hike from the European Central Bank in September.

The strategists identified potential upside risks to their new dollar forecast, including a conflict between the U.S. and Iran that could disrupt oil shipments or an artificial intelligence investment boom that could stoke inflation and force the Fed to resume hiking interest rates.