Dollar slides 0.9% in August as Treasury buybacks, Fed signals collide

The Bloomberg Dollar Spot Index fell 0.9% in August, extending July's 1.3% decline, as Treasury buyback expansion and Fed Chair Kevin Warsh's hawkish stance pulled the currency in opposite directions.

"The Fed's reaffirmation of its inflation target eased concerns about policy credibility, but Bessent's interventionist approach adds another dimension of policy risk for the dollar," said Tatiana Darie, macro strategist at Markets Live.

Warsh's Friday pledge to restore inflation to 2 percent triggered a one-day dollar surge, but the currency fell 0.2 percent Monday. Traders now price more than 50 percent probability of a September rate hike, while one-month dollar implied volatility has risen notably over the past two trading days.

The policy crosscurrents leave the dollar vulnerable if the Fed fails to deliver the hike markets have priced. Friday's nonfarm payrolls report will be the first test, with Wells Fargo strategist Erik Nelson warning that a miss could extend dollar weakness through September.

Bessent's decision to expand Treasury buybacks from $2 billion to at least $4 billion per operation — announced Aug. 19 and effective Sept. 9 — has reignited speculation that U.S. policy is aimed at guiding the dollar lower. The Treasury secretary said Monday the agency "hasn't bought a single bond yet" and will continue its regular auction program, but the move has already reshaped expectations for the Nov. 4 quarterly refunding announcement.

The buyback expansion, which Bessent dubbed a "Treasury twist," raised the stakes for the $31 trillion Treasury market. Deutsche Bank, Morgan Stanley and Citigroup are now war-gaming a potentially bigger shift in the government's borrowing strategy, including the radical option of cutting sales of long-dated bonds. More likely, the Treasury could signal at the November refunding that future increases in borrowing will be done via bills and shorter-maturity notes.

Bank of America strategists led by Meghan Swiber called the shift "a new regime" of activist debt management. BMO Capital Markets' Ian Lyngen said reductions to bond auction sizes "can no longer be ruled out," while Morgan Stanley's Martin Tobias described the expanded buybacks as "a bridge until November refunding."

The 30-year Treasury yield surged to 5.32 percent before easing to about 5.19 percent, as the buyback announcement initially lowered yields on longer-dated securities before they largely retraced. Bessent said the program aims to support liquidity in the thinly traded 30-year sector, which is also competing with heavy corporate bond issuance tied to the artificial intelligence buildout.

Fiscal dominance concerns mount

The policy interplay has raised questions about who controls the levers of monetary policy. EY-Parthenon chief economist Gregory Daco warned of "fiscal dominance," where the Fed takes instruction from the Treasury. Evercore ISI senior economist Marco Casiraghi said the expanded buybacks could weaken the dollar and fuel higher inflation.

Warsh's preference for a "trimmed average" inflation measure — which would show lower inflation than current methods — complicates the picture. His aversion to forward guidance means every data release becomes a potential repricing trigger.

The Treasury could fund the expanded buybacks from its roughly $1 trillion general account, according to CNBC, citing anonymous sources. That would avoid issuing new bonds, potentially reducing supply and driving up long-term bond prices. But the Treasury could still issue new debt to finance the purchases, and Bessent has said the regular auction program will continue.

Nonfarm payrolls as the first test

Friday's U.S. nonfarm payrolls report will be the first critical data point. Bank of America FX strategist Alex Cohen said August data will be key: weak employment and inflation could suppress rate-hike expectations, but any upside surprise would present another major credibility test for the Fed.

The dollar has fallen in five of the first eight months of the year, marking its longest losing streak since February. If the Fed fails to deliver the priced-in September hike, Wells Fargo's Nelson expects dollar weakness to persist through the month.

This article is for informational purposes only and does not constitute investment advice.