Dollar Outlook Comes Under Pressure as Investors Question Treasury and Fed Credibility

The U.S. dollar is heading into the new week under renewed scrutiny after BofA Securities said risks have shifted lower as investors reassess how Washington is responding to the rise in long-term borrowing costs. The concern is not simply that Treasury yields are high. BofA’s argument is that efforts to ease pressure at the long end, if they are not matched by fiscal restraint and a clearly independent Federal Reserve response, could leave the exchange rate carrying more of the adjustment.

At the center of the debate is the Treasury Department’s August 19 decision to increase the size of liquidity-support buybacks for longer-dated nominal securities. Beginning September 9 and running through November 4, the maximum size of operations in the 10-year to 20-year and 20-year to 30-year sectors will rise from $2 billion to at least $4 billion per operation. Treasury said the change is intended to provide greater liquidity support in markets where it has been receiving strong participation and high-quality offers. It did not describe the program as a formal attempt to peg or cap long-term yields.

BofA interpreted the timing differently. In a note reported by Investing.com on Sunday, the bank said announcing the increase outside the regular quarterly refunding process suggested that containing long-term borrowing costs had become an important policy objective. It warned that trying to suppress yields without corresponding fiscal restraint could increase pressure on the dollar because the currency may have to absorb more of the adjustment. That is an analyst interpretation of the policy signal, not Treasury’s stated rationale.

Long-bond buybacks brought relief, but yields stayed elevated

Yields show why the credibility question has gained traction. The Federal Reserve’s H.15 series put the 30-year Treasury constant-maturity yield at 5.28% on August 18, 5.19% on August 19 after the buyback announcement, and 5.23% on August 20. The 10-year yield followed a similar pattern, moving from 4.71% to 4.65% and then back to 4.69%. The first reaction therefore eased the immediate stress without returning long-term borrowing costs to earlier levels.

Higher U.S. yields also failed to translate into the usual degree of currency support. Reuters reported on Friday that the dollar index was around 98.8 and that the euro was near a three-month high against the U.S. currency. BofA said the dollar’s weakness following the Treasury announcement, alongside strength in gold and the Swiss franc, was consistent with investors treating the issue as a broader policy-confidence question rather than a simple change in rate differentials.

Buybacks also have a mechanical limit. In its August 3 borrowing estimates, Treasury said repurchases are not expected to have a significant effect on privately held net marketable borrowing because new issuance replaces securities that are bought back. The department expects to borrow $739 billion in privately held net marketable debt during the July to September quarter and $628 billion in the October to December quarter. Its program can improve liquidity in older securities and alter the way supply is distributed across the curve, but it does not remove the government’s underlying financing requirement.

Temporary liquidity support, in other words, does not by itself improve the fiscal outlook. Treasury Borrowing Advisory Committee minutes released earlier this month said the median primary-dealer forecast implied a $1.45 trillion funding shortfall in fiscal 2027 and 2028 under current coupon auction sizes and privately held bill supply. Dealers generally expected coupon sizes to begin rising sometime in 2027, a reminder that the long end is being asked to absorb substantial financing needs even after the latest buyback adjustment.

The Fed’s inflation stance is the other half of the currency trade

Minutes from the July 28 to 29 Federal Open Market Committee meeting, released on August 19, do not show a central bank preparing an easy policy response. Officials voted 9 to 3 to keep the federal funds target range at 3.5% to 3.75%, while Beth Hammack, Neel Kashkari and Lorie Logan preferred a quarter-point increase. Many participants judged that further tightening would probably be necessary if inflation did not decline, and some questioned whether financial conditions were restrictive enough to return inflation to the 2% objective.

BofA’s downside case is therefore conditional rather than automatic. A Federal Reserve that is willing to raise rates when inflation remains too high can support the currency by preserving confidence in price stability and maintaining an interest-rate advantage over other economies. Pressure would be more likely to deepen if investors concluded that financial conditions were being kept too accommodative, particularly if balance-sheet policy were perceived as helping absorb a heavier supply of Treasury bills while Treasury simultaneously tried to relieve pressure at longer maturities.

June inflation data still give policymakers a reason to be cautious. The Bureau of Economic Analysis reported that the personal consumption expenditures price index rose 3.7% in the year through June, while the core measure excluding food and energy increased 3.3%. Both readings remained well above the Fed’s 2% goal even though monthly inflation cooled. At the same time, the July FOMC minutes said longer-run inflation expectations remained consistent with the 2% objective, meaning the central bank had not lost the expectations anchor that policymakers view as critical.

Policy credibility therefore cuts in two directions. If Treasury is seen as addressing market liquidity while the Fed independently responds to inflation, the dollar could regain support even if long yields remain uncomfortable. If markets instead come to believe that both institutions are increasingly focused on suppressing financing costs without a convincing fiscal or inflation strategy, BofA’s argument is that the currency could absorb more of the pressure.

August inflation data and Jackson Hole will test the outlook

Two scheduled events arrive quickly. The Bureau of Economic Analysis is due to release July personal income and spending data, including the Fed’s preferred PCE inflation measures, on August 26. Two days later, Fed Chair Kevin Warsh is scheduled to deliver keynote remarks at the Jackson Hole Economic Policy Symposium. Together they will give investors a fresh basis for judging whether the central bank is prepared to tighten again if inflation stays elevated and whether its reaction function remains separate from Treasury’s debt-management priorities.

Less than three weeks later, the FOMC meets on September 15 and 16. A firmer inflation-fighting message or stronger price data could push rate expectations higher and potentially give the dollar support, all else equal. Softer inflation would reduce the need for higher policy rates, but the currency response may still depend on whether investors view lower yields as a healthy disinflation story or as part of a broader effort to make heavy U.S. financing needs easier to carry.

Because U.S. markets were closed Sunday, BofA’s latest warning had not yet faced a fresh full trading session at the time of publication. The dollar’s next move will be judged against more than the level of Treasury yields alone. The relationship among Treasury’s buyback program, the Fed’s inflation stance and the government’s financing needs has become part of the currency risk premium itself, which is why policy credibility is moving closer to the center of the dollar debate.