US Dollar: Shaky basis trade risks weigh – Commerzbank

Commerzbank’s Volkmar Baur explains how the US Treasury Secretary’s vague secondary sanctions comments and falling US yields have left the Dollar stabilizing but vulnerable. He highlights hedge funds’ leveraged basis trades in US Treasuries and recalls episodes like “Liberation Day” where rising yields coincided with a weaker Dollar, concluding that rising US debt and shifting investor base are not supportive for the Dollar.

Basis trades and Dollar vulnerability

"The US Treasury Secretary’s press conference on Monday provided little details on which countries would be affected by potential secondary sanctions - or to what extent. And perhaps even more important: no timeline for their implementation was mentioned. As a result, the US dollar stabilized again during yesterday’s trading."

"In principle, rising interest rates should support the US dollar, while falling rates tend to weigh on it. However, turbulence in recent months has shown that the opposite can also be true."

"The currently high proportion of hedge funds among US Treasury investors could therefore lead to sudden, sharp fluctuations in the bond market reinforcing themselves as basis trades must be unwound and US Treasuries come under selling pressure."

"Viewed from this perspective, the US intervention in the yen and the expansion of the buyback program for illiquid long-term Treasury bonds were not a favor to Japan or a small helping hand for the market, but rather market interventions taken as a precaution to prevent worse outcomes. The problem: Last week showed that interventions in the bond market tend to come at the expense of the US dollar."

"“Liberation Day”, in turn, demonstrated that sudden rises in interest rates can also lead to a weak dollar in the current environment. Meanwhile, US debt continues to rise, and new buyers for US Treasuries must be found. Not a favorable environment for the US dollar, then."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)