Dollar Slumps and Gold Rallies as US Treasury Ramps Up Buybacks

Dollar Tumbles as Treasury Expands Bond Buybacks

The US dollar dropped to a 2.5-month low on Wednesday after the Treasury announced it would at least double the maximum size of its liquidity support buyback operations for longer-dated nominal coupons, to at least $4 billion per operation, effective September 9. The Bloomberg Dollar Spot Index fell as much as 0.7%, with the currency losing ground against all major counterparts. The dollar index (DXY00) was down 0.76%, according to Barchart.

The move came amid a steady selloff in the bond market that had pushed 30-year yields to their highest level since 2007, signaling concern over surging federal debt, inflation, and other pressures. The Treasury's announcement fueled a rally in longer-dated Treasuries, pulling down 30-year yields by about eight basis points.

The dollar has also been dragged down by speculation that the Federal Reserve is unlikely to start raising interest rates before December. Traders were awaiting minutes from the latest Fed meeting later on Wednesday to gauge whether calls for further tightening gained traction.

Rand Strengthens, Yen Jumps

The rand strengthened from R16.25/$ to below R16.08 within minutes of the announcement, its best level in more than five months, and was trading around R16.10 by late afternoon. The yen also rallied, jumping as much as 0.9% to trade at 158.17 to the dollar, its strongest level in more than a week.

EUR/USD rallied to a 2.5-month high, up 0.77%, while USD/JPY fell 0.83%. The yen also found support after data showed Japanese June core machine orders rose more than expected, and lower T-note yields supported the currency. However, a rally in crude oil prices to a 3-week high was seen as a bearish factor for both the Eurozone and Japan, which import most of their energy.

Fed and BOJ Rate Expectations

The markets are discounting a 35% probability of a 25-basis-point rate hike at the next FOMC meeting on September 15-16. For the European Central Bank, markets are pricing in a 95% chance of a 25-bp hike at its policy meeting on September 10. For the Bank of Japan, markets are discounting a 77% chance of a 25-bp hike at the September 18 meeting, according to a Bloomberg report that Japanese Prime Minister Sanae Takaichi's government supports a BOJ rate hike in September or October. The BOJ's current policy rate is 1.00%, well below the Fed's federal funds rate target range of 3.50%-3.75%.

Analyst Views: 'A More Settled Bond Market'

"A more settled bond market today has allowed the dollar to fall back," said Jane Foley, head of FX strategy at Rabobank. "This is against the backdrop of inflation and supply risks in addition to fears that higher hedge fund ownership of government debt could make the market more jittery."

Howard Du, a strategist at TD Securities in New York, said, "The dollar is broadly lower on the back of the US Treasury headline."

Treasury's Broader Strategy and 'Financial Repression'

Treasury Secretary Scott Bessent surprised Wall Street on Wednesday with the plan to increase buybacks of long-term bonds. The move came just weeks after the US and Japan took joint action to boost the yen for the first time in three decades. To support the yen, the US sold euros instead of dollar-denominated assets, avoiding a sale of Treasuries that would put more upward pressure on yields. Japan, the world's largest holder of US debt, tapped the Federal Reserve's Foreign and International Monetary Authorities (FIMA) Repo Facility to borrow dollars against its Treasury stockpile, obtaining a limited form of liquidity without selling its holdings.

George Saravelos, head of FX research at Deutsche Bank, said, "We see both the buyback and encouragement to use the FIMA facility for FX reserves as soft-form financial repression policies aimed at containing the long-end of the US yield curve."

Financial repression refers to policies that enable a government to keep interest rates artificially low by influencing financial markets. Historically, the US and other developed economies used financial repression to slash debt-to-GDP ratios after World War II. A survey of 300 years of US and UK history found that wars are "always disaster times" for holders of government debt because of inflation and financial repression.

Saravelos warned that suppressing Treasury yields will shift the impact to the dollar, potentially causing it to weaken. Since the buyback announcement, markets have ramped up bets on the "debasement trade," with gold and bitcoin prices surging. October COMEX gold rose 2.09% to $109.40, and September COMEX silver gained 2.19% to $1.403. Gold ETFs had fallen to a 10.25-month low on July 27, and silver ETFs to a 1-year low on July 14, but have since rebounded. China's PBOC reserves rose by 640,000 ounces in July, the twenty-first consecutive month of increases, to 76.08 million troy ounces.

The federal budget deficit is on track to hit $2 trillion this fiscal year, with debt interest costs at $1 trillion annually. An IMF research paper said conditions are ripe for another wave of financial repression.