The US dollar has declined for two consecutive months; the US Treasury buyback program has forced speculators to retreat, and the hawkish stance of Waller only resulted in a one-day rebound.

Although Federal Reserve Chair Walsh reiterated the 2% inflation target, fueling expectations of a rate hike, Wells Fargo warns that the Federal Reserve may not deliver, and dollar weakness could continue.

Written by: Bao Yilong, Wall Street Insights

With the Federal Reserve reaffirming its determination to fight inflation and the US Treasury accelerating its government bond repurchases, the dollar extended its decline in August, marking the second consecutive monthly drop.

In August, US Treasury Secretary Besant unexpectedly announced an expanded government bond repurchase plan, shocking overseas investors and reigniting speculation that US policies are intended to guide the dollar lower.

Hedge funds, asset management firms, and other speculators subsequently reduced their bullish dollar positions. On Monday, Besant publicly stated that he and Federal Reserve Chair Walsh are "aligned" on bond issues.

This series of signals suppressed the dollar’s rebound momentum. Despite Walsh's vow last Friday to restore US inflation to the 2% target, which led to a single-day surge for the dollar, the dollar fell back 0.2% on Monday; the Bloomberg Dollar Spot Index dropped 0.9% in August, extending July’s 1.3% decline.

Traders have increased bets on a Federal Reserve rate hike this year, with market pricing for a September hike exceeding 50%. However, Wells Fargo strategist Erik Nelson warns that if the Federal Reserve fails to deliver the rate hikes the market has priced in, dollar weakness could extend into September.

US Treasury repurchases trigger long position unwinding, interventionism dominates dollar pricing

The Bloomberg Dollar Spot Index fell 0.9% in August, extending July’s 1.3% drop. Five out of the first eight months this year saw declines, marking the longest losing streak since February.

The core catalyst for the downturn comes from US Treasury debt management operations. Besant announced earlier this month the expansion of government bond repurchasing, shaking overseas investors and reigniting speculation that US policy is aimed at weakening the currency.

Markets Live macro strategist Tatiana Darie pointed out that Walsh’s reiteration of the inflation target eased concerns about monetary policy credibility, but Besant’s latest statement reminds investors that his interventionist approach brings another dimension of policy risk for the dollar.

Hawkish comments temporarily pause the decline, rate hike expectations rise

Walsh’s hawkish statements last week about the inflation target prompted a brief dollar rebound and spurred markets to reprice for a rate hike. Traders are now betting the probability of a Federal Reserve rate hike in September is above 50%.

Wells Fargo strategist Erik Nelson believes this pricing may not last. He stated: The Federal Reserve may not deliver the rate hikes priced in for September, and the dollar will weaken in September.

It is noteworthy that Walsh traditionally dislikes forward guidance, which means every economic data point could trigger a market repricing. The one-month implied volatility of the dollar index has risen significantly over the past two trading days.

Policy signals intersect, non-farm data becomes the key variable

With policy signals from the Federal Reserve and Treasury woven together, market sensitivity to macro data is rising sharply.

This week’s focus shifts to Friday’s US non-farm payrolls report. Because Walsh has shown his aversion to forward guidance, each upcoming data point becomes more important and may become a market catalyst.

Bank of America FX strategist Alex Cohen indicates US August data will be critical — weak employment and inflation could restrain rate hikes, but any upside surprise will pose another major credibility test for the Federal Reserve.

Friday’s non-farm payrolls report will be the first key moment to test the subsequent trajectory of the dollar.