US Dollar Pressured as Treasury Yield Suppression Raises Policy Credibility Concerns: BofA

The U.S. dollar faces further downside risk as investors question whether moves by the Treasury Department to suppress long-term yields will erode confidence in American economic policy, according to a report from BofA Securities.

Treasury Action Sparks Concern

The analysis follows a U.S. Treasury announcement that it would at least double the maximum size of its long-dated bond buybacks to $4 billion per operation, up from a previous maximum of $2 billion. The operations are scheduled to take place between September 9 and November 4.

BofA Securities noted that the timing of the announcement, which occurred outside the regular quarterly refunding process, suggests the primary goal is to contain borrowing costs rather than to improve market liquidity. The bank argued that suppressing yields without corresponding fiscal restraint could force the exchange rate to act as the main adjustment mechanism, putting downward pressure on the dollar.

Market Reaction and Fed's Role

Following the Treasury's announcement, the dollar weakened while safe-haven assets like gold and the Swiss franc outperformed, BofA reported. U.S. equities also declined despite lower 10-year Treasury yields, a move the bank interprets as a signal of renewed concern over policy credibility.

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The Federal Reserve's response is now seen as critical. According to the report, an accommodative Fed stance, particularly if it absorbs increased Treasury bill issuance onto its balance sheet, would strengthen the case for selling the dollar against higher-beta currencies.

Analyst Outlook

BofA analysts suggest the dollar's problems may be structural rather than a temporary reaction to lower rates. This view is supported by increased demand in the options market for protection against dollar declines, particularly against the euro, Swiss franc, and Swedish krona.

In light of this outlook, the bank added to its dollar short positions by recommending a long position in NZD/USD at 0.5957, with a target of 0.62. The recommendation is based on expectations for two more rate increases from the Reserve Bank of New Zealand and potential support for the country's export prices from disruptions to global food supplies. The main risk to the trade, BofA noted, is a broad equity market selloff.