Dollar weakness exposes US policy premium

USD: Dollar weakness exposes US policy premium

The dollar remains near three-month lows even as US real yields climb. The 10-year real yield has risen about 70 basis points from its 18-month low, while DXY has fallen to around 99. In earlier cycles, this yield move would have produced a stronger dollar. Instead, investors are demanding higher returns to hold US assets because fiscal pressure and policy intervention have weakened confidence in the Treasury market’s signal.

The latest Treasury buyback announcement reinforced that disconnect. Doubling long-end purchases from September 9 briefly lowered yields, but the 30-year yield soon reversed much of the decline. Buybacks can improve liquidity in selected securities, but they cannot remove heavy duration supply or create lasting demand. Repeated efforts to contain borrowing costs also make it harder to judge whether higher yields reflect strong US growth or greater policy uncertainty.

The fixed income market is raising estimates of the long-run neutral policy rate as growth stays resilient, inflation remains firm and the Fed keeps rate cuts off the table. A neutral rate near 3.7% would place fair value for the 10-year yield around 4.7% to 4.9%. Current yields are therefore approaching fair value rather than showing a clear overshoot, while fiscal risks remain only partly priced.

The buyer base is also becoming less supportive. Rising Japanese yields give domestic investors a stronger reason to repatriate capital instead of owning Treasuries with currency and hedging risk. At the same time, large deficits and limited political support for fiscal restraint point to continued US debt growth. Higher yields increasingly represent compensation for supply, fiscal risk and policy uncertainty, so they provide less support for the dollar.

Trade and geopolitical tensions add further crosscurrents and narrative volatility. The collapse of US-Canada trade talks threatens regional growth, while tougher Iran sanctions could lift oil prices and oil-linked dollar demand. The PCE report on Wednesday and Jackson Hole on Friday may decide whether DXY breaks below 98.80 or recovers toward 100. Until the US policy premium narrows, however, rallies toward 100 should remain tactical and vulnerable to reversal.

CAD: Trade shock reverses Loonie’s recovery

USD/CAD has jumped to 1.3852 from last Thursday’s cycle low of 1.3760 as the trade dispute returns with greater force. Talks collapsed after the final text reportedly differed from Canada’s understanding of the agreement. The US then imposed 50% tariffs on about $20 billions of Canadian goods, prompting Canada to announce equal counter-tariffs from September 8. A further threat to raise tariffs on Canadian autos, parts and steel to 50% from January 2027 has widened the economic risk.

The escalation has quickly weakened Canada’s improving macro-outlook. The Canadian two-year yield has fallen to 2.94%, widening its gap with the US equivalent to about 129 basis points. Markets are now questioning whether the Bank of Canada can raise its policy rate toward 3% by July 2027. Federal support may cushion affected firms and workers, but it cannot fully protect investment, employment or supply chains from a prolonged tariff regime.

This shift has also reversed the technical picture for USD/CAD. The pair had declined 2.6% from its July high of 1.4125 as strong Canadian data and trade optimism supported the loonie. That move is now unwinding, with 1.39 emerging as the first major resistance level. A sustained break above it would strengthen the case for a move toward 1.40 to 1.41 as markets price a longer and more damaging dispute.

The January auto tariff threat presents the largest forward risk because components often cross the border several times before final assembly. US PCE on Wednesday and Jackson Hole on Friday, could provide some relief through broader US dollar weakness, but Canadian trade risks will continue to drive the pair. Renewed negotiations before the September 8 deadline could trigger a sharp CAD recovery. Without a credible path back to talks, however, rallies in the Loonie are likely to struggle and USD/CAD will remain biased toward 1.40.

MXN: Peso carry defies rising geopolitical risk

USD/MXN is trading near 16.96, close to its strongest level since May 2024, despite rising geopolitical risk. Second-quarter GDP rebounded by 1.4%, and inflation moved above Banxico’s target midpoint. These conditions support a prolonged rate hold and preserve the peso’s carry appeal.

Mexico’s yield advantage remains the main source of peso strength. The two-year yield offers a premium of about 293 basis points over the US, while the long-end spread remains close to 250 basis points. Banxico’s unanimous hold at 6.50% and delayed inflation convergence forecast suggest that this advantage will persist. Strong reserves, nearshoring investment and AI-related exports add further support, even as global equity sentiment weakens.

USD/MXN is now testing support near 16.90 after breaking through several key levels since its July peak. A sustained move lower would expose 16.80, although crowded peso positioning raises the risk of a sharp reversal. China’s response to Iran sanctions, US PCE on Wednesday and Jackson Hole on Friday are the main near-term catalysts, while a wider North American trade conflict could introduce fresh pressure. Carry and technical momentum favour the peso, but any shock that forces investors to cut risk could send USD/MXN higher.

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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.