Macroscope | Is the US dollar smile starting to fade amid economic headwinds?
- Higher interest rates, tighter credit conditions and a steadily depleting stock of household savings all add to the case for a US recession and potentially a period of weak global growth
- So shouldn’t this mean an appreciation in the US dollar? It depends.
Read enough about currencies and you’ll come across the term “dollar smile”. When times are good and risk sentiment is high, the US dollar usually does well, as investors flock to the growth potential of US assets. Alternatively, when times are bad and investors are cautious, they seek out high-quality safe havens like US Treasuries, creating upward pressure on the US dollar.
These are the two corners of the US dollar smile. When the outlook is mediocre, investors usually seek out investment opportunities outside the United States, and the greenback depreciates.
As with all good answers, it starts with “it depends”; in this case, on the time frame. While currencies can be exceptionally noisy and move quickly on any given day, week or month, the US dollar tends to move in longer cycles of alternating strength and weakness.
From the mid-1990s until the early 2000s, the US dollar climbed steadily, then entered a period of prolonged depreciation for the best part of 10 years, before starting the current climb again in 2012.
There are reasons to believe that the most recent decline may be the start of a longer downward cycle in the US dollar story. The elevated price of the US dollar stands in contrast to the fundamentals of the US economy and the shorter-term impacts of growth and interest rate differentials between the US and the rest of the world.
