"More Paths for Dollar Weakness Are Opening": MUFG on Why US Treasury Buybacks Could Backfire

The dollar index extended its decline, trading near 98.73, after the US Treasury unexpectedly doubled the size of its long-dated bond buybacks to lower borrowing costs, but market reactions suggest the move could prove counterproductive. George Goncalves, head of US macro strategy at MUFG Securities Americas, noted that when yields in countries like Japan are already attractive enough for domestic investors, dollar weakness triggering inflation could backfire, and the fate of the US bond market—especially long-dated bonds—is closely tied to the dollar.

**Buyback Expansion Fuels Inflation Concerns**

The Treasury's buyback operation was intended to lower long-term rates, but the market has interpreted it as a potential inflation catalyst. Over the past two days, as the dollar fell, long-term Treasury yields climbed sharply, with the 30-year yield rising about 7 basis points relative to the 2-year yield, marking the largest single-day move in months and exhibiting a classic "bear steepening" pattern—where long-end yields rise faster than short-end yields, and investors typically anticipate a potential resurgence of inflation. Meanwhile, long-dated Treasury Inflation-Protected Securities outperformed benchmark Treasuries, further confirming that the market views dollar volatility as an inflation signal.

**Foreign Demand Faces Dual Squeeze**

Persistent dollar weakness could erode foreign investor demand for US Treasuries, with roughly one-third of US government debt currently held by overseas investors. Analysts point out that if dollar turbulence persists, it could deepen the "sell America" trade risk spiral seen in financial markets at the start of this year. When domestic yields in major Treasury-holding countries like Japan are already attractive, dollar depreciation combined with rising inflation expectations could prompt these investors to reduce their Treasury allocations, paradoxically pushing up US long-term borrowing costs and running counter to the Treasury's policy intent.

**Policy Tools Under Scrutiny**

Market signals show that tools such as the Federal Reserve's FIMA repo facility could provide foreign central banks a path to access dollar liquidity without selling Treasuries, but the buffer effect of these tools remains to be seen amid the broader trend of dollar weakness. MUFG's view highlights the current policy dilemma: efforts to lower borrowing costs may fuel inflation expectations through the exchange rate channel, thereby pushing yields higher instead, creating a self-defeating cycle.