Dollar Slides as Treasury Steps In to Cap Long-Term Yields

The Treasury Department said it would double its buybacks of long-term government bonds. The dollar dropped to a three-month low on the news.

The Dollar Index lost 0.8% on a trade-weighted basis. EUR/USD climbed above 1.17 for the first time since late May.

The expanded buyback program covers off-the-run securities with at least 10 years remaining to maturity. The Treasury plans seven buyback operations from Sept. 9 through October, purchasing roughly $28 billion of long-term debt. That is double the previously planned $14 billion.

The announcement came two days after the 30-year Treasury yield reached 5.32%, the highest since 2007. The 10-year yield hit 4.74%. The sell-off in government bonds had spread to Australia, New Zealand and Japan. Investors were concerned about rising US government spending, public debt above $40 trillion, and the growing debt of technology companies financing data-center and AI investments.

Brent crude rose above $90 a barrel as Middle East tensions escalated. Donald Trump showed no interest in extending the Iran agreement. Fighting in Lebanon intensified. The lack of progress on reopening the Strait of Hormuz kept oil prices elevated. That threatened to reignite inflation and complicate the Federal Reserve's policy outlook.

Two softer inflation prints and weaker US labor data had earlier reduced expectations of a September rate increase. Higher energy costs strengthened the case for the Fed to hold a restrictive stance, traders said.

The expanded buyback program is small compared with the Fed's peak quantitative easing of $120 billion a month. Unlike the central bank, the Treasury cannot create money to fund the purchases. The buybacks will likely be financed through increased issuance of short-term bills. The operation resembles the 2011–2012 Operation Twist more than conventional QE, analysts said. The direct effect on yields is probably limited. The more important signal is that the Treasury appears to have a borrowing-cost level beyond which it will intervene.

A contradiction is emerging. Fed Chair Kevin Warsh has argued that market interest rates should help fight inflation. The Treasury stepped in when higher long-term yields became too painful for the economy and public finances. Such intervention could weaken the tightening of financial conditions and undermine the credibility of the inflation fight, analysts said.

Washington's actions also imply that when forced to choose between higher debt-servicing costs and a weaker currency, the administration may accept dollar depreciation. Bond buybacks increase demand at the long end of the curve and may reduce the term premium. They also make dollar-denominated assets less attractive, traders said.

The expansion does not signal an immediate dollar crisis. The currency still benefits from high interest rates, the depth of US financial markets, and capital inflows into the technology sector. Periods of dollar weakness may still be interrupted by sharp rebounds, traders said.

The past week has shown there are politically acceptable limits to the rise in Treasury yields. If investors conclude that reducing the cost of servicing public debt has become more important than protecting the currency, downward pressure on the dollar could become more persistent, analysts said.

The Japanese yen may be the main beneficiary, particularly if the US–Japan yield gap narrows. Gold and the Swiss franc are also potential alternatives to the dollar. The euro has room to rally further if the trend continues, traders said.