US Dollar Faces Headwinds from Shifting Yields and Inflows, BCA Research Says

BCA Research is advising investors to sell the U.S. dollar against a basket of currencies including the Japanese yen and the euro, citing a fundamental shift in U.S. real interest rates and a potential slowdown in foreign portfolio inflows.

Key Drivers for Dollar Weakness

The firm's bearish view on the dollar is based on its expectation that U.S. “core real yields” are set to decline. BCA Research defines this measure as the inflation-protected Treasury yield after stripping out the bond term premium. According to the analysis, recent increases in U.S. yields have been driven more by higher fiscal and inflation-related term premiums, which tend to weaken the dollar, rather than by stronger growth expectations that are typically supportive.

Another critical factor is the potential for weakening foreign investment. BCA noted that significant foreign purchases of U.S. equities, fueled by enthusiasm for artificial intelligence, have helped finance the large U.S. current-account deficit and supported the dollar. The firm anticipates these inflows will slow, particularly if high-priced U.S. technology stocks see a downturn.

Recommended Currency Positions

BCA Research recommends establishing long positions against the U.S. dollar in several currencies backed by strong current-account surpluses. These are expected to provide support as international investors potentially reduce their exposure to U.S. assets.

The recommended currencies include:

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• South Korean won (KRW)
• Japanese yen (JPY)
• Taiwan dollar (TWD)
• Singapore dollar (SGD)
• Euro (EUR) (for which the firm holds the Hungarian forint as a proxy)

While BCA also expects the Chinese yuan to appreciate against the dollar, it believes Chinese authorities will likely intervene to limit the gains. Conversely, the firm expects the Brazilian real, Indonesian rupiah, and Philippine peso to underperform, making them less attractive alternatives.

Broader Market Implications

A weaker dollar outlook informs BCA's broader asset allocation strategy. The firm recommends underweighting U.S. equities while maintaining a substantial overweight position in Japanese stocks and a modest overweight in European equities.

According to BCA, a falling U.S. dollar should also provide support for gold and gold-mining shares. The firm also favors non-U.S. government bonds, particularly after any potential near-term selloffs. The euro may also act more defensively as European investors recycle less of their surplus capital into American securities.