US dollar could crash after 20 years if Fed halts rate hikes

• In 2022, the dollar jumped more than 10% against other major currencies, strengthening to levels not seen since 2002.
• But a shift by the Fed away from its aggressive rate hike campaign would drive the dollar lower, economist Barry Eichengreen said.
• The idea that inflation will stay in the high numbers and the Fed will continue its tightening cycle is “pretty silly,” he wrote in the Financial Times.

The U.S. dollar remains near 20-year highs, but a shift by the Federal Reserve away from its aggressive rate hike campaign would reverse the direction of the greenback, a top economist has said.

In 2022, the dollar jumped more than 10% against other major currencies, strengthening to levels not seen since 2002, as the Fed pushed interest rates higher at a faster pace than others. the world’s central banks, said UC Berkeley economist Barry. Eichengreen recently wrote in the Financial Times.

Russia’s war on Ukraine, rising US-China tensions over Taiwan and geopolitical risks related to Iran could also bolster the dollar’s status as a safe haven for investors.

“But ultimately, recent currency moves have been driven by central banks. So will the future,” Eichengreen said.

With the Fed behind the curve to tame inflation, the market has already priced in the expectation of further rate hikes, which means any future increases are unlikely to push the dollar higher, he noted.

Meanwhile, central banks in other countries are becoming more aggressive with their own rate hikes, and the dollar has already slipped against a basket of other major currencies, he added.

And the risk of a U.S. recession is growing precipitously, while current dollar prices are based on expectations that the Fed will continue to raise rates amid economic expansion, Eichengreen said.

In fact, government data released Thursday showed the US economy contracted for a second straight quarter – an unofficial definition of a technical recession.

“The idea that under these recessionary circumstances inflation will remain in the high numbers and the Fed will therefore be forced to continue its tightening cycle, is pretty stupid,” Eichengreen wrote ahead of the GDP data release.

As stocks rallied sharply on Wednesday following Fed Chairman Jerome Powell’s comment that a slowdown in rate hikes is likely as policy turns tighter, central bank watchers on Wall Street warned that the market was misinterpreting the Fed.

For example, Renaissance Macro Research predicted that inflation would not fall fast enough for the Fed to pivot. Piper Sandler said Powell’s remarks are “not the words of a Fed chair moving into a dovish stance.” And NatWest Markets analysts said the outlook for the federal funds rate could even rise.

But in Eichengreen’s view, there are few signs that inflation will be tenacious enough to require continued aggressive rate hikes.

“So if the economy and inflation weaken, the Fed will pause and the dollar will reverse direction. This is no longer a risk that can be dismissed,” he concluded.