US Dollar: Fed hold tempers dollar rebound – NBC

National Bank of Canada's (NBC) Stéfane Marion and Kyle Dahms note that the US Dollar (USD) has weakened broadly in Q3 even as the United States (US) economy remains at full employment. They argue that sharply higher long-term Treasury yields are tightening financial conditions and limiting scope for renewed Fed hikes. Their fixed-income team expects the Federal Reserve to stay on hold this year, keeping the trade-weighted Dollar near recent lows.

Higher yields curb Fed tightening risk

"Under these circumstances, one might ask what would prevent the Fed from soon raising its policy rate for the first time since 2023 and, in the process, putting a floor under the greenback. As Fed Chair Kevin Warsh recently put it in his inaugural Jackson Hole speech, “yesterday’s news has a way of getting mistaken for what is happening right now.” That observation is particularly relevant in the bond market."

"While markets continue to price some risk of additional Fed tightening, our fixed-income strategists still expect the central bank to remain on hold this year. A key reason is the significant rise in long-term yields, which has already tightened financial conditions. Importantly, much of that increase appears to reflect a higher term premium stemming from a deteriorating fiscal backdrop rather than a renewed surge in inflation expectations."

"It is certainly not weaker economic growth that is undermining the currency. The labour market surprised sharply to the upside in August, with payrolls surging by 162,000, nearly three times the consensus expectation of 55,000, while the unemployment rate held at 4.1%. That remains below the Congressional Budget Office’s estimate of the non-accelerating inflation rate of unemployment (NAIRU), suggesting that the U.S. economy remains at, if not beyond, full employment."

"Moreover, the weakness has been broad-based, with all major currencies except the Swiss franc gaining ground against the U.S. dollar so far in Q3."

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