Financial markets are full of paradoxes once again. The Treasury’s buyback program failed to cool the market and halt the treasury yield rally. Yields on 10-year notes have hit their highest levels since 2007. What can put an end to this rally is not the Treasury’s bond purchases, but an actual Fed rate hike, backed by Kevin Warsh’s tough “hawkish” rhetoric. How will the US dollar behave under these conditions? The question remains open. It is no surprise that speculators are massively closing their positions ahead of the FOMC decision, which has temporarily allowed EURUSD to find support and stabilize at current levels.
There is no consensus on the effectiveness of the authorities’ actions. Treasury Secretary Scott Bessent insists that the buyback program is working, and without it, government bond yields would have soared even higher. However, the market disagrees: nearly half of the asset managers surveyed by Bank of America consider the program ineffective, and 29% are outright convinced that the Treasury’s actions paradoxically raise rates rather than lower them. Given the high correlation between the US dollar and treasury yields, one might expect the American currency’s reaction to the Fed’s verdict to perfectly mirror the movements in the debt market. But in reality, it is much more complicated.
If the Fed refuses to raise rates, or raises them but fails to provide the market with clear guidance on future tightening steps, this will trigger a new wave of rising yields on long-term treasuries. Investors simply will not believe in the central bank’s determination to fight inflation uncompromisingly. To compensate for inflation risks, they will demand a higher premium on long-term securities.
Historical experience suggests that in the last eight instances, the 10-year yield breaking above the 5% mark proved to be short-lived. On average, it took about 12 days to correct downward. The Fed has an excellent opportunity to confirm this pattern. However, there is a catch: Kevin Warsh’s reluctance to give the market direct guidance could be interpreted as covert “dovish” positioning. This would only fuel further yield growth. But will the dollar follow suit? There are significant doubts about that.
The futures market is virtually certain of a September rate hike (92% probability) and assigns a 79% chance to two tightening cycles in 2026. Essentially, this scenario is already “priced in” to the current EURUSD quotes. For the pair to continue its plunge, the market will need grounds to price in three steps of monetary policy tightening. Currently, the probability of such an outcome is estimated at only 30%.
The trigger for this scenario could be either revised FOMC macroeconomic projections or extremely hawkish comments from Kevin Warsh. In either case, the US dollar will get a powerful impulse to strengthen. But if the Committee limits its signal to two rate hikes, and the Fed Chair announces nothing fundamentally new, the greenback, on the contrary, risks losing ground.
