- In 2022, the dollar has 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 send the dollar lower, economist Barry Eichengreen said.
- The idea that inflation will remain in the high single digits and the Fed will continue its tightening cycle is "quite daft," he wrote in the Financial Times.
The US dollar remains near 20-year highs but a shift by the Federal Reserve away from its aggressive rate-hike campaign would reverse the greenback's direction, a top economist said.
In 2022, the dollar has jumped more than 10% against other major currencies, strengthening to levels not seen since 2002, as the Fed has pushed interest rates higher at a more rapid pace than other central banks around the world have, UC Berkeley economist Barry Eichengreen wrote in the Financial Times recently.
Russia's war on Ukraine, rising US-China tensions over Taiwan, and geopolitical risks related to Iran may also be bolstering the dollar's status as a safe haven for investors.
"But at the end of the day, recent currency movements have been driven by central banks. The same will be true going forward," Eichengreen said.
With the Fed behind the curve on taming inflation, the market has priced in the expectation of additional rate hikes already, meaning any future increases are unlikely to move the dollar any higher, he noted.
Meanwhile, central banks in other countries are getting more aggressive with rate hikes of their own, and the dollar already slipped against a basket of other major currencies, he added.
And the risk of a US recession is rising precipitously, while current dollar pricing is based on expectations that the Fed will continue to raise rates amid an expanding economy, Eichengreen said.
In fact, government data out Thursday revealed the US economy contracted for a second consecutive quarter — an unofficial definition of a technical recession.
"The idea that, in these recessionary circumstances, inflation will remain in the high single digits and the Fed will therefore be forced to continue its tightening cycle, is quite daft," Eichengreen wrote before the GDP data came out.
While stocks rallied sharply Wednesday on Fed Chairman Jerome Powell's comment that a slowdown in rate hikes is likely as policy gets more restrictive, central bank watchers on Wall Street warned the market is misreading the Fed.
For instance, Renaissance Macro Research predicted inflation is unlikely to come down fast enough for the Fed to pivot. Piper Sandler said Powell's remarks are "not the words of a Fed chair who is pivoting towards a dovish stance." And analysts at NatWest Markets said the outlook on the fed funds rate could even go higher.
But in Eichengreen's view, there is little sign that inflation will be stubborn 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.