With inflation still above 3%, why hasn't the US dollar strengthened significantly in line with interest rates?
2026-08-27 16:01:02
On Thursday, August 27, the US dollar index was last quoted at approximately 99.15. Over the past month, the dollar index has fallen from above 101 to around 99. Market focus is shifting from a simple interest rate path to the repricing of fiscal bond operations, the Fed's inflation constraints, and long-term term premiums. More significant changes are occurring in the bond market. The US Treasury announced that, starting September 9, it will increase the size of its liquidity support repurchase agreements for 10- to 20-year and 20- to 30-year bonds from a maximum of $2 billion per transaction to at least $4 billion, continuing until November 4. Bessant subsequently indicated that the actual repurchase size could still exceed $4 billion. This means that the dollar is no longer facing a simple trade-off between interest rate cuts and hikes, but a more complex issue: when the US Treasury actively influences the supply and demand structure of long-term bonds, while the Fed still faces inflation significantly above its 2% target, should the dollar be priced according to short-term policy rates, long-term real rates, or fiscal risk premiums? 
The most noteworthy aspect of this bond repurchase is not the absolute figure of $4 billion. Considering the overall size of the Treasury market, this amount is insufficient to constitute a large-scale asset purchase in the traditional sense. What truly changes market expectations is the policy function. The US Treasury defines the measures as liquidity support, citing a decline in the depth of trading in long-duration bonds. However, Bessant recently clarified that some long-term yields do not reflect fundamentals, and that the repurchase itself also has a signaling effect. This naturally leads to a second interpretation: the operational objective is no longer solely limited to improving the liquidity of existing bonds, but also aims to mitigate the impact of abnormally high long-term yields on financial conditions. Previously, the 30-year yield had risen to its highest level since 2007, falling significantly after the repurchase announcement, but subsequently rebounding, indicating that the market is distinguishing between liquidity issues and fundamental risks. Therefore, a more accurate understanding of this round of policy changes is not that the US Treasury is replacing the Federal Reserve in implementing monetary policy, but rather that the fiscal side is beginning to have a more significant impact on the long-term structure of the yield curve. This will reduce the effectiveness of simply explaining dollar fluctuations through expectations of Fed policy. The latest data does not provide the Fed with significant room to ease policy constraints. The U.S. Personal Consumption Expenditures (PCE) price index rose 3.7% year-on-year in July, while the core index rose 3.3% year-on-year, with both figures increasing by 0.2% month-on-month. Personal income grew by 0.4% and personal consumption expenditure by 0.2% during the same period, with real consumption essentially flat. The second estimate of real GDP growth in the second quarter remains at an annualized rate of 1.5%. In other words, the current macroeconomic combination is not a typical case of rapid demand decline coupled with a rapid drop in inflation, but rather a slowdown in economic growth while inflation remains sticky. The Federal Reserve has maintained the target range for the federal funds rate at 3.50% to 3.75% since the beginning of the year, and policy reports continue to emphasize the 2% inflation target. Following the release of the latest inflation data, the market has re-priced in the possibility of further policy tightening. This also explains why fiscal measures aimed at lowering long-term financing costs create a noteworthy policy tension. The degree of monetary policy constraint is not solely determined by overnight rates. Corporate financing, housing financing, and asset valuations are more directly affected by medium- and long-term interest rates. If fiscal operations continue to reduce the long-term term premium, it may marginally ease financial conditions, while the Federal Reserve is still using relatively tight financial conditions to curb inflation. Therefore, the specific interest rate signals Warsh released at Jackson Hole are not the only focus. The market needs to observe how he defines the boundary between US Treasury bond repurchase agreements and monetary policy. Warsh previously reduced traditional forward guidance and emphasized allowing the market to play a greater role in price discovery. Recently, the market has been waiting for him to re-explain how the Fed views the relationship between inflation, long-term yields, and financial conditions. The US dollar index is currently around 99.15, significantly lower than the level above 101 in late July. On August 19, the day the US Treasury expanded its long-term bond repurchase program, the dollar index quickly fell from around 99.67, eventually closing around 98.83. Although it has since recovered somewhat, it has not yet returned to its previous trading range. This performance indicates that the traditional positive correlation between yields and the dollar is becoming more complex. If the decline in long-term yields stems from a decrease in inflation expectations or a reduction in real policy tightening pressure, dollar pricing usually adjusts through the real interest rate channel. However, if the decline in yields mainly comes from the US Treasury directly changing bond supply and demand, then the information released by the decline in nominal yields is not as pure as it used to be. For the foreign exchange market, changes in real interest rates and policy credibility are more important. With inflation still above 3%, and the fiscal authorities aiming to limit the rapid rise in long-term financing costs, the market needs to reassess how much of the nominal interest rate comes from real growth, how much from inflation compensation, how much from term premiums, and how much is being influenced by policy operations. This is also the most easily overlooked layer in the current dollar trading logic. The dollar is no longer simply a reflection of the Fed's interest rate expectations, but is increasingly affected by relative changes in fiscal financing structure, long-term debt supply, term premiums, and the independent pricing of central bank policies. Looking at the daily chart, after a rapid decline, the dollar index formed a temporary low around 98.55, followed by a series of small-bodied candlesticks for recovery, and is currently back around 99.15. The Bollinger Band middle line is around 99.87, the upper line around 101.53, and the lower line around 98.20. The current price has moved away from the extreme area near the lower band, but is still trading below the middle band. From a purely technical perspective, this indicates that the short-term price deviation has converged, while the medium-term moving average structure is still in an adjustment phase. The MACD also reflects this characteristic. In the chart, DIF is approximately -0.4044 and DEA is approximately -0.3797, both still below the zero axis, and the absolute values of the histogram bars are already at a low level. This does not mean that it provides a signal for future direction, but rather that the negative momentum generated by the previous rapid decline is weakening, but the trend strength indicator has not yet completed its correction from the negative area to the neutral area.
The most noteworthy aspect of this bond repurchase is not the absolute figure of $4 billion. Considering the overall size of the Treasury market, this amount is insufficient to constitute a large-scale asset purchase in the traditional sense. What truly changes market expectations is the policy function. The US Treasury defines the measures as liquidity support, citing a decline in the depth of trading in long-duration bonds. However, Bessant recently clarified that some long-term yields do not reflect fundamentals, and that the repurchase itself also has a signaling effect. This naturally leads to a second interpretation: the operational objective is no longer solely limited to improving the liquidity of existing bonds, but also aims to mitigate the impact of abnormally high long-term yields on financial conditions. Previously, the 30-year yield had risen to its highest level since 2007, falling significantly after the repurchase announcement, but subsequently rebounding, indicating that the market is distinguishing between liquidity issues and fundamental risks. Therefore, a more accurate understanding of this round of policy changes is not that the US Treasury is replacing the Federal Reserve in implementing monetary policy, but rather that the fiscal side is beginning to have a more significant impact on the long-term structure of the yield curve. This will reduce the effectiveness of simply explaining dollar fluctuations through expectations of Fed policy. The latest data does not provide the Fed with significant room to ease policy constraints. The U.S. Personal Consumption Expenditures (PCE) price index rose 3.7% year-on-year in July, while the core index rose 3.3% year-on-year, with both figures increasing by 0.2% month-on-month. Personal income grew by 0.4% and personal consumption expenditure by 0.2% during the same period, with real consumption essentially flat. The second estimate of real GDP growth in the second quarter remains at an annualized rate of 1.5%. In other words, the current macroeconomic combination is not a typical case of rapid demand decline coupled with a rapid drop in inflation, but rather a slowdown in economic growth while inflation remains sticky. The Federal Reserve has maintained the target range for the federal funds rate at 3.50% to 3.75% since the beginning of the year, and policy reports continue to emphasize the 2% inflation target. Following the release of the latest inflation data, the market has re-priced in the possibility of further policy tightening. This also explains why fiscal measures aimed at lowering long-term financing costs create a noteworthy policy tension. The degree of monetary policy constraint is not solely determined by overnight rates. Corporate financing, housing financing, and asset valuations are more directly affected by medium- and long-term interest rates. If fiscal operations continue to reduce the long-term term premium, it may marginally ease financial conditions, while the Federal Reserve is still using relatively tight financial conditions to curb inflation. Therefore, the specific interest rate signals Warsh released at Jackson Hole are not the only focus. The market needs to observe how he defines the boundary between US Treasury bond repurchase agreements and monetary policy. Warsh previously reduced traditional forward guidance and emphasized allowing the market to play a greater role in price discovery. Recently, the market has been waiting for him to re-explain how the Fed views the relationship between inflation, long-term yields, and financial conditions. The US dollar index is currently around 99.15, significantly lower than the level above 101 in late July. On August 19, the day the US Treasury expanded its long-term bond repurchase program, the dollar index quickly fell from around 99.67, eventually closing around 98.83. Although it has since recovered somewhat, it has not yet returned to its previous trading range. This performance indicates that the traditional positive correlation between yields and the dollar is becoming more complex. If the decline in long-term yields stems from a decrease in inflation expectations or a reduction in real policy tightening pressure, dollar pricing usually adjusts through the real interest rate channel. However, if the decline in yields mainly comes from the US Treasury directly changing bond supply and demand, then the information released by the decline in nominal yields is not as pure as it used to be. For the foreign exchange market, changes in real interest rates and policy credibility are more important. With inflation still above 3%, and the fiscal authorities aiming to limit the rapid rise in long-term financing costs, the market needs to reassess how much of the nominal interest rate comes from real growth, how much from inflation compensation, how much from term premiums, and how much is being influenced by policy operations. This is also the most easily overlooked layer in the current dollar trading logic. The dollar is no longer simply a reflection of the Fed's interest rate expectations, but is increasingly affected by relative changes in fiscal financing structure, long-term debt supply, term premiums, and the independent pricing of central bank policies. Looking at the daily chart, after a rapid decline, the dollar index formed a temporary low around 98.55, followed by a series of small-bodied candlesticks for recovery, and is currently back around 99.15. The Bollinger Band middle line is around 99.87, the upper line around 101.53, and the lower line around 98.20. The current price has moved away from the extreme area near the lower band, but is still trading below the middle band. From a purely technical perspective, this indicates that the short-term price deviation has converged, while the medium-term moving average structure is still in an adjustment phase. The MACD also reflects this characteristic. In the chart, DIF is approximately -0.4044 and DEA is approximately -0.3797, both still below the zero axis, and the absolute values of the histogram bars are already at a low level. This does not mean that it provides a signal for future direction, but rather that the negative momentum generated by the previous rapid decline is weakening, but the trend strength indicator has not yet completed its correction from the negative area to the neutral area.
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