Dollar can climb higher even if the Fed “steps down”

The US dollar looks set to end the week lower amid a rally in most riskier assets and currencies, driven in large part by renewed hopes that the Fed and other major central banks will soon slow the pace of policy tightening. This notion has been fuelled by the BoC’s unambiguously dovish 50bp hike and the ECB’s language yesterday in announcing a 75bp hike. Alongside weak activity data in the US and elsewhere, this has helped to reinforce hopes that the Fed too might soon slow. While we think the Fed may indeed hint at a slower pace of rate hikes when it meets next week, we don’t think the FOMC will welcome the loosening of financial conditions over the past couple of weeks. We think the near-term risks to US interest rates remain to the upside and that by the time the FOMC’s focus shifts, the darkening outlook for global growth will drive the dollar higher as safe-haven demand increases – as has been the case in most recent global recessions.