Do you know : The Dollar Smile Theory ?

You've probably noticed that US dollar seems to strengthen even more whenever the world economy is fluctuating or going through a crisis. This factor has left many investors intrigued by the behavior of the American currency on the international financial market and has been observed for a long time by the most experienced economists.

To make the analytical process even more complex, the phenomenon of the dollar strengthening occurs even if the American economy is internally in chaos and is not at his best.

Well, maybe it's not so easy to understand the theory at first, but imagine right now a smiley face from end to end: at the left end of the smiley face we have the US dollar strengthening with risk aversion; at the bottom of the smiley face, we have the US financial market going down, and at the right end of the smiley face, we have the dollar strengthening with economic growth. The three scenarios presented work like a graph designed to show the behavior of the US dollar.

The strengthening of the dollar due to high risk aversion

The first scenario describes how the dollar continues to strengthen ahead of a worrying scenario, and is the left edge of the smile.

This type of situation is called risk aversion, which is characterized by situations in which an investor is faced with a volatile scenario in the financial market in which it is not possible to predict the behavior of a currency or asset.

Investors therefore choose to place capital in currencies that are considered safe, such as those that maintain the same value or have an upward trend, like the US dollar, for example.

At the first sign that the world economy could suffer major fluctuations, investors begin to prefer low-risk investments so as not to lose capital, opting instead for the security offered by less unstable assets, such as US debt.

On a global scaleThis usually happens even if there is an internal imbalance in the US economy. If an investor wants to buy US treasury bonds, he will need US dollars, leading to an imminent strengthening of the country's currency, even at critical times.

In this way, the growth of the dollar becomes a much safer bet for directing capital, precisely because it is the product of a large financial market and has the liquidity that investors need to gain some control even in the midst of instability.

The fall in the dollar due to the loss of strength in the American economy

The basis of Jen's smile theory is a fall in the American currency due to a loss of economic strength in the United States, such as a severe recession. In this case, the dollar reaches a minimum value caused by the contraction of the economy and the stagnation of areas of the market.

While the country struggles to get on its feet financially, there are sudden drops in interest rates that also have a direct influence on the currency situation, creating an aversion to the dollar for all investors.

Seeking to move away from the currency's downturn, investors make the quick decision to sell the US dollar rather than buy it so that there is no risk of losing capital. And so, the dollar is sidelined by more profitable options on the market to make more profit due to the high interest rates of these other currencies.

Even if the U.S. economic imbalance is down, but not at its worst, the mere fact that the U.S. is underperforming other countries will cause investors around the world to dump their dollars and migrate to the more attractive currencies of a country with a consolidated economy.

The law of the market is still to obtain higher yields, so the safest option is to sell the US dollar while there is still time.

The strengthening of the dollar due to economic prosperity

Representing the right part of the top of the smile, this scenario is characterized by the appreciation of the American currency in view of an economic acceleration in the country. After periods of imminent risk and market recession, the sun is once again shining on the horizon, bringing an exponential improvement to American pockets and forming the smile.

Confidence is beginning to spread among investors around the world, who are overwhelmed by the sudden optimism over the improving economic situation in the United States, which also increases confidence in the strength of the dollar abroad.

This confidence is due to the signs of recovery and economic progress shown by the powerhouse. As the financial market rises once again and the country begins to reap the rewards of its progress, the US is showing optimistic GDP growth and satisfactory expectations for future living standards. These signs shake away the prospect of recession and offer hope for prosperity.

When we take a closer look at the global situation in the face of the pandemic, we see that all countries are suffering the serious economic effects, leading to a contraction of the financial market.

The current scenario of instability is considered a high-risk scenario, causing all investors to opt for safer asset options such as the US dollar, even though the United States is experiencing economic problems, as are several other countries around the world.

[ipt_fsqm_form id="9″]

The dollar is still considered a safe option And, as we are witnessing after more than 12 months of the global pandemic, even with the political crisis and ideological differences within the US comparable to the polarization in Brazilian politics strong institutions and a large domestic economy in addition to the country's economic strength, the American economy is recovering quickly, reinforcing the thesis that even in bad times having investments in dollars can be a way of reducing risks or balancing investment portfolios.

Despite its reaction to domestic economic growth, the dollar is still a safe haven currency. If we analyze the The Smile TheoryIt is possible to observe that whenever the US pushes the world financial market towards a major recession or even through periods of development, the American currency tends to appreciate.

But what should we expect from now on? Well, we should bear in mind that the world's economies have a cyclical rhythm, they slow down, lose strength and then recover, and so on, and this will not change.

What we can do in this scenario is to keep an eye on the development of the American economy, trying to understand the moment it is facing. Only in this way will it be possible to predict the possible progress of the dollar using the The Smile Theory.

SUMMARY

Did you like the article? Keep an eye on our blog! Looking to live or invest in real estate in Florida? Check out the list of houses for sale in Florida that we've selected for you!