Bank of America: Global central banks slow rate hikes as AI volatility becomes a new variable for FX markets

Central banks slow rate hikes: Why did the dollar fall first, and why might it benefit later?

The Fed held rates steady in October, the Bank of Canada raised rates but remained cautious about further action, the European Central Bank held steady, and the Reserve Bank of New Zealand unexpectedly paused rate hikes. BofA believes these meetings collectively point to a more gradual pace of tightening.
The Fed chair attributed the pause to tighter financial conditions, and BofA believes this explanation raised market doubts about the credibility of the fight against inflation. The dollar fell about 0.25% after the meeting, less than the roughly 0.5% decline following the July meeting; market pricing for a rate hike in December changed only slightly.
BofA still expects the Fed to raise rates once each in December 2026 and March 2027, taking the terminal rate to 4.25%–4.5%. The bank believes the dollar could later gain support if slower initial tightening means rates need to stay higher for longer.

BofA observes that the dollar has become more sensitive to AI trades and less closely correlated with oil prices; if a US equity sell-off is concentrated mainly in technology stocks, the dollar may receive less support from safe-haven demand.
According to the bank, since 2026 the weekly returns of the New Taiwan dollar, Chilean peso and South African rand have had correlations of 53%, 48% and 45%, respectively, with AI-themed ETF AIQ. The New Taiwan dollar's recent weakness has also coincided with accelerating portfolio equity outflows; the Chilean peso and South African rand are more heavily influenced by global risk sentiment.
The yen has a lower correlation with AIQ. BofA believes potential capital repatriation when risk appetite falls makes shorting the New Taiwan dollar against the yen or the Thai baht against the yen an option for hedging AI risk events.

BofA is bullish on the yen and expects USD/JPY to reach 152 at the end of 2026, citing improving Japanese fundamentals, potentially faster Bank of Japan rate hikes and potential asset rebalancing by public pension funds.
Japanese life insurers are also gradually returning funds to the domestic bond market. Annualizing investment in the first half of fiscal 2026, life insurers could make net purchases of about 3.8 trillion yen in long-term Japanese government bonds for the full year; they made net sales of about 2.1 trillion yen in fiscal 2025.
However, BofA believes the purchases mainly involve replacing low-coupon bonds with higher-coupon bonds and are not large enough to significantly depress long-term government bond yields. Most life insurers remain cautious about foreign bonds.

BofA estimates that AUD/USD is about 0.71 below its model equilibrium value, but believes the Australia–US interest-rate differential and risk sentiment will matter more than commodity prices over the coming year.
Unlike the mining boom of 2010–2011, the recent rise in commodity prices has not been accompanied by a comparable increase in Australian mining investment, capacity and export volumes. About half of planned capital expenditure is still directed to iron ore, much of it to replace depleted capacity; copper projects are constrained by scarce resources, long development cycles and capital intensity.
The Australian dollar remains linked to commodities, although BofA believes its relationship with copper and broad commodity prices is stronger than with iron ore.

BofA expects Swedish growth to outpace Norway's and forecasts that Sweden's central bank will raise rates by 25 basis points in both the fourth quarter of 2026 and the first quarter of 2027; Norway's central bank rate may already have peaked at 4.5%.
The bank expects NOK/SEK to fall to 1 at the end of 2026 and to 0.95 in 2027: Swedish domestic demand and Europe-related investment support growth, while Norway faces slowing real wage growth and pressure from high rates.
In the short term, European natural gas prices risk rising in winter, which could support the Norwegian krone and delay the move described above; if energy prices remain high, Norway's central bank could also raise rates once more before the first quarter of 2027.