Dollar Weakness Continues Amid Tightening Financial Conditions

The US Dollar has weakened significantly in Q3 despite the US economy being at full employment. According to Stéfane Marion and Kyle Dahms of National Bank of Canada's (NBC), sharply higher long-term Treasury yields are tightening financial conditions, limiting the 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. They argue that the significant rise in long-term yields has already tightened financial conditions and is unlikely to prompt additional Fed tightening.

The labour market in the US surprised sharply to the upside in August, with payrolls surging by 162,000, nearly three times the consensus expectation of 55,000. The unemployment rate held at 4.1%, below the Congressional Budget Office's estimate of the non-accelerating inflation rate of unemployment (NAIRU), suggesting that the US economy remains at full employment.

The weakness in the Dollar has been broad-based, with all major currencies except the Swiss franc gaining ground against it so far in Q3. This has led Stéfane Marion and Kyle Dahms to conclude that the central bank will remain on hold this year due to tighter financial conditions.