What is the Dollar Smile theory?

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The Dollar Smile Theory

Ever wonder why the dollar strengthens both in times of tough luck and when the economy is booming like a Beyoncé single?

Well, so does everybody else. In fact, this really smart dude over at Morgan Stanley came up with a theory to explain this phenomenon.

.., a former currency strategist and economist, came up with a theory and named it the “Dollar Smile Theory.”

The Dollar Smile Theory Explained

His theory depicts three main scenarios directing the behavior of the U.S. dollar. Here’s a simple illustration:

Scenario #1: USD Strengthens Due to Risk Aversion

The first part of the smile shows the U.S. dollar benefiting from risk aversion, which causes investors to flee to “safe-haven” currencies like the dollar and the yen.

Since investors think that the global economic situation is shaky, they are hesitant to pursue risky assets and would rather buy up the less risky U.S. dollar regardless of the condition of the U.S. economy.

Scenario #2: USD Weakens to New Low Due to Weak Economy

Dollar drops to a new low.

The bottom part of the smile reflects the lackluster performance of the Greenback as the U.S. economy grapples with weak fundamentals.

The possibility of interest rate cuts also weighs the U.S. dollar down.

This leads to the market shying away from the dollar. The motto for USD becomes “Sell! Sell! Sell!”

Scenario #3: USD Strengthens Due to Economic Growth

The dollar appreciates due to economic growth.

Lastly, a smile begins to form as the U.S. economy sees the light at the end of the tunnel.

As optimism picks up and signs of economic recovery appear, sentiment towards the dollar begins to pick up.

In other words, the greenback begins to appreciate as the U.S. economy enjoys stronger GDP growth and expectations of interest rate hikes increase.

For more:

https://www.hsb.co.id/learn/forex/the-dollar-smile-theory.html

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The dollar smile is a theory that says the U.S. currency tends to increase in value against other currencies when the U.S. economy is extremely weak or very strong. It goes up at either end of the spectrum, just like the smile on your face.

https://www.wsj.com/articles/what-is-the-dollars-smile-11591539293

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US dollar: A new trend underway? – Standard Chartered

NEWS | Jul 23, 01:58 GMT | By Dhwani Mehta

Having forecasted the US dollar to weaken around 7% over the next year, the Standard Chartered Analysts points to a likely beginning of a new trend in the US dollar trading.

Key quotes

“USD has been weakening during NY trading hours over the past few days.

Likely to continue if US asset managers continue selling during the domestic sessions.

If this is the start of a new trend of USD selling during US hours, it could be significant as it would signal that we are entering the middle of the USD smile.

‘Dollar smile’ analysis, the currency tends to strengthen in a crisis, weakens when the global economy is healthy and rebounds again when the US outperforms.”

https://www.fxstreet.com/news/us-dollar-a-new-trend-underway-standard-chartered-202007230158

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What Is the Dollar’s ‘Smile’?

The theory says the U.S. currency tends to increase in value against other currencies when the U.S. economy is either extremely weak or strong.

By Simon Constable
Updated June 7, 2020 8:30 pm ET

Investors sometimes talk about the “smile” of the U.S. dollar. What does it mean?

The dollar smile is a theory that says the U.S. currency tends to increase in value against other currencies when the U.S. economy is extremely weak or very strong. It goes up at either end of the spectrum, just like the smile on your face.

https://www.wsj.com/articles/what-is-the-dollars-smile-11591539293

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1 Response to What is the Dollar Smile theory?

  1. Pingback: Much has been made of the impending demise of the US Dollar… | weehingthong

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