Why is the USD still falling despite the Fed remaining hawkish?

The U.S. Dollar Index (DXY) remains under strong selling pressure and has now fallen to around 98.5–98.6, extending its decline after breaking below the 99 level.

Notably, the U.S. dollar continues to weaken even as the latest FOMC meeting minutes show that the Federal Reserve (Fed) remains cautious about inflation risks.

In my view, this suggests that the market is no longer focusing solely on the Fed’s interest rate outlook, but is also paying closer attention to developments in the U.S. Treasury market, particularly following an unexpected move by the U.S. Treasury Department.

The July FOMC minutes showed that the Fed remains cautious about inflation risks. At the July 28–29 meeting, the Fed kept interest rates unchanged at 3.50%–3.75%, while three members supported a 25-basis-point rate hike and many officials continued to leave the door open to further tightening if inflation fails to make further progress toward the 2% target.

However, this hawkish signal provided little support for the USD, as the minutes reflected the Fed’s views before more recent data showed signs of weakness in the labour market and easing inflation, reducing expectations for another rate hike.

More direct pressure on DXY came from the U.S. Treasury Department. On August 19, the Treasury unexpectedly announced that it would at least double the size of its liquidity-support buybacks for longer-dated securities with maturities of 10 years or more, raising the maximum amount from $2 billion to at least $4 billion per operation starting in September.

The move came after the 30-year U.S. Treasury yield climbed to 5.337%, its highest level in 19 years, amid concerns over inflation and the U.S. fiscal outlook. Following the announcement, the 30-year yield quickly reversed course, falling by around 9 basis points to approximately 5.18%.

The decline in long-term yields quickly put pressure on the USD. DXY fell below the 99 level and was trading around 98.5 during the Asian session on August 20, near its lowest level since mid-May, while the euro, yen, British pound and Swiss franc all strengthened against the U.S. dollar.

However, it is important to note that the Treasury’s buyback program is not equivalent to quantitative easing (QE) by the Fed. The official objective of the move is to improve liquidity and functioning in the Treasury market rather than directly ease monetary policy. Nevertheless, the strong market reaction suggests that investors are particularly sensitive to any measures that could reduce upward pressure on long-term U.S. Treasury yields.

In my view, this is also the most important factor for DXY’s near-term outlook. The Fed has not actually turned dovish, and inflation risks have not disappeared, but these factors have so far been insufficient to generate a sustained recovery in the U.S. dollar. The market is now balancing a Fed that remains cautious about inflation against a Treasury market that is sending increasingly complex signals about growth, public debt and financial conditions.

In the near term, if Treasury yields continue to ease and expectations for further Fed rate hikes fail to recover, DXY could remain under pressure around its current lows. Conversely, the USD’s ability to rebound will largely depend on whether upcoming economic data prompt markets to reconsider the possibility of further Fed tightening. Therefore, movements in U.S. Treasury yields could play a role just as important as the Fed’s policy signals in determining the next direction for DXY.