The dollar faces further downside as investors question whether Treasury bond-buyback moves and the Federal Reserve's response will erode confidence in U.S. policy, according to BofA Securities. The bank ties the greenback's weakness to expanded Treasury buybacks and flags a long NZD/USD trade as its preferred way to play the trend.
BofA Securities said the dollar faces further downside as investors question whether Treasury efforts to suppress long-term yields, and the Fed's response to them, will weaken confidence in American policy. The bank's warning follows a Treasury announcement that it would at least double the maximum size of long-dated bond buybacks, to $4 billion per operation from $2 billion, between September 9 and November 4.
Treasury's timing raises credibility questions
BofA said the announcement's timing, outside the regular quarterly refunding process, suggested the Treasury was primarily trying to contain long-term borrowing costs rather than improve market liquidity. Suppressing yields without corresponding fiscal restraint could leave the exchange rate as the main adjustment mechanism, the bank said, placing downward pressure on the dollar.
The greenback weakened after the announcement, while gold and the Swiss franc outperformed. U.S. equities also declined despite lower 10-year Treasury yields, a combination BofA read as renewed concern about policy credibility.
Fed's next move will be decisive
BofA said the Fed's response will be critical. Accommodative financial conditions, particularly if the central bank absorbs increased Treasury bill issuance through its balance sheet, would strengthen the case for selling the dollar against higher-beta currencies. The bank added that weakness across both funding and risk-sensitive currencies suggested the dollar's problems may be structural rather than a temporary response to lower interest rates.
Demand for protection against dollar declines has increased in options markets, particularly against the euro, Swiss franc and Swedish krona. Still, BofA noted that short- and longer-dated currency volatility remains historically inexpensive.
BofA adds to dollar shorts via NZD/USD
BofA added to its dollar shorts by recommending a long position in NZD/USD at 0.5957, with a target of 0.62 and a stop at 0.58. The bank expects two additional rate increases from the Reserve Bank of New Zealand, and weather-related disruption to global food supplies could also support New Zealand's export prices and currency.
Technical indicators have turned more constructive after NZD/USD broke above two resistance levels. The main risk to the trade, BofA said, is an equity selloff that pressures higher-beta currencies.
Source: Investing.com
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