The Dollar Smile Theory
2 min read
US Dollar Smile Theory in Forex signifies that US Dollar can strengthen both in good & bad market conditions.
There are times once you get to the market expecting to ascertain the US dollar falling but to your surprise it is making higher highs, showing no signs of getting down.
According to the idea, the dollar does best when the important financial world looks either excellent or bad.
There is a domestic U.S. dollar which behaves like any other currency. Economy’s relative outlook and potential investment returns are linked with it.
There is also an international U.S. dollar that’s used because the primary currency utilized in global trade (for payments) and also needed to shop for U.S. government bonds which are coveted for their safety.
This international U.S. dollar strengthens for a spread of reasons when markets are volatile and global growth slows.
Stephen Jen, a former economist at the International fund and Morgan Stanley, who now runs a hedge fund and advisory firm Eurizon SLJ Capital in London, came up with a theory and named it the Dollar Smile Theory.
- THE USD RISES DUE TO RISK AVERSION
During the periods of economic instability, investors run to the USD seeking a secure haven no matter the US economic status.
When the worldwide economic conditions are bad, most of the investors prefer keeping their wealth in USD and therefore the Yen instead of the riskier currencies.
This is because no matter the economic conditions, the USD is believed to be a stable and powerful currency.
- THE USD FALLS TO NEW LOWS, (ECONOMIC SLOWDOWN AND RECESSION)
As the US economy struggles the Dollar starts bottoming within the market giving signs of poor performance of the greenback and weak economy.
There is an opportunity of a possible rate of interest cut by the Fed push the dollar further down.
Meanwhile, investors withdraw from buying it to selling it off and now choose higher yielding currencies.
- US ECONOMY IS VERY STRONG – DOLLAR SMILE COMPLETE
The strong economic process attracts more foreign investors within the US resulting in tons of capital flow into the economy.
This may cause raising of the rate of interest by FED, low unemployment, strong consumer confidence and a robust GDP.
As a result, the greenback appreciates hence strengthening the dollar and completing the smile.
This theory applied in 2007 financial crisis.
