US Dollar: Bearish regime reinforced by bull flattener – TD Securities

TD Securities strategists argue that the United States (US) Treasury buyback announcement has reinforced bearish momentum for the Dollar. Using US Dollar Index (DXY), SPX and UST 5s30s data since 1999, they find that bull flattening alongside stronger US equities tends to weigh on the Dollar, while a US equity shock could still trigger a rebound in 2026.

Bull flattening weighs on Dollar outlook

"The US Treasury buyback announcement on August 19 caused the long-end 30y Treasury yield to fall by almost 10bp on the day and led to a bull flattening curve dynamic."

"Conventional wisdom would have been for the USD to rally when the UST curve bull flattened. Historically, the UST curve tends to bull flatten on the back of US risk-off shocks. The "flight-to-quality" phenomenon would increase short-term demand for long-dated Treasuries and the USD"

"However, in the uncommon circumstance when US equities gained during a UST bull flattening backdrop, the USD on average would see a modest -0.3% weakness instead of a sharp 1.74% rally. The combination of UST bull flattening and higher US equities has been the second rarest across the 8 possible UST curve dynamics and equity scenarios."

"The USD was one breath away from its bearish turn after muted CPI and negative retail sales July data. Rising US institutional credibility concerns and risk of financial repression after the UST buyback announcement cemented the prevailing bearish USD momentum."

"While we anticipated the USD to eventually fall back to a bearish regime at some point in H2 '26, the move has played out earlier than we expected."

"Alternatively, the USD could also rally if a US equity shock were to materialize while UST curve does not bull steepen. Historically, the bull steepening curve dynamic would be the most bearish for the USD and could outweigh the equity effect as it tended to occur amid Fed rate cuts in Q3 '24 and Q4 '25."

"For now, market consensus expectations continue to point toward upside for US equities. Nonetheless, we see this scenario as the biggest tail risk for the USD in 2026."

"For now, the market has been gradually pricing out near-term Fed rate hike expectations after US data disappointments so far in Q3, and our base case is also for the Fed to stay on hold."

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