Do you know : The Dollar Smile Theory ?

Do you know : The Dollar Smile Theory ?

You have probably noticed that US dollar seems to strengthen even more whenever the world economy is fluctuating or undergoing a crisis. This factor has left many investors intrigued by the behavior of the American currency in 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 dollar strengthening phenomenon happens even if the American economy is internally in chaos and is not at its best.

A simple and useful way to understand why this happens is to imagine that there are two "types" of US dollars.

  1. Domestic DollarIt behaves like any other currency. It is tied to the outlook for the economy and the potential returns on domestic investment.

  2. International Dollar: which is used as the main currency in global trade (for payments) and also needed to buy US government bonds that are coveted for their safety.

This international" US dollar strengthens for a number of reasons when markets are volatile and global growth slows down.

When some kind of "shock" occurs, whether in the US or abroad, and it is big enough to cause investors and traders to panic and financial markets to fall, this is likely to cause the US dollar to appreciate.

This strengthening of the dollar under any circumstances led to Stephen JenMorgan Stanley's foreign exchange strategist and economist, to formulate the The Smile Theory.

Despite the curious name, Jen's proposed theory that the US dollar is able to strengthen incredibly in good and bad financial market times, makes a lot of sense. Just look closely at the currency's trend in recent years.

The theory was first proposed in 2007, when the crisis in the U.S. real estate sector was beginning to emerge, in what subsequently became a period of catastrophic losses and a severe recession, driving the U.S. economy into the ground.

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Stephen Jen He worked for thirteen years at the global financial services company Morgan Stanley, holds a PHD in economics from MIT, and is now CEO of a foreign exchange company.

According to Stephen Jen's theory, the dollar is capable of performing well regardless of whether the timing is good or bad, but why? It is exactly these questions that Jen aims to answer with the The Smile TheoryThis is the first time we have seen the dollar's behavior even with the ups and downs of the financial market.

Jen's theory is called The Smile Theory precisely because of its shape, the smilewhich in English means "smile", is used to represent market trends.

Well, maybe it is not so easy to understand the theory at first, but imagine right now an end-to-end smile, on the left end of the smile we have the U.S. dollar strengthening with risk aversion; at the bottom of the smile, we have the U.S. financial market down, and already on the right end of the smile, we have the dollar strengthening along with the economic growth. The three scenarios presented work as a graph made 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 worrisome scenario, being the left end of the smile.

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

Thus, investors 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 might suffer from major oscillations, investors start to prefer low-risk investments, in order not to lose capital, opting for the safety offered by less unstable assets, such as American debt.

On a global scaleThis usually happens even if there is an internal imbalance in the US economy. If an investor wishes 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 to direct capital, precisely because it is the product of a large financial market and has the liquidity that investors need to obtain some control even in the midst of instability.

The lowering of the dollar due to the loss of strength of the U.S. economy

At the bottom of Jen's theory of smiling, we have a fall in the American currency, seen from the loss of economic strength in the United States, such as a strong recession. In this case, the dollar reaches a minimum value caused by the contraction of the economy and the stagnation of market areas.

As the country struggles to get back on its feet financially, there are sudden drops in interest rates that also directly influence the currency environment, creating an aversion to the dollar for all investors.

Looking to get 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 capital loss. And so the dollar is pushed aside by more profitable options in 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. has a lower economic performance than other countries will cause investors around the world to dump their dollars and migrate to more attractive currencies of a country with a consolidated economy.

The law of the market is still to get 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 the periods of imminent risk and market recession, the sun shines again on the horizon, bringing exponential improvement to American pockets and forming the smile.

Confidence begins to spread among investors around the globe, who are seized by sudden optimism in the face of the improving economic situation in the United States, also increasing confidence in the strength of the dollar abroad.

The confidence is due to the signs of recovery and economic advances demonstrated by the powerhouse. As the financial market rises once again and the country begins to reap the rewards of its progress, the USA is showing optimistic GDP growth and satisfactory expectations for future living rates. Such signs shake off the prospect of recession and provide hope for prosperity.

When we take a closer look at the global situation in the face of the pandemic, we see that all countries have been suffering the severe economic effects leading to the 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.

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

Despite its reaction to domestic economic growth, the dollar still has the function of a safe haven currency. If we analyze the The Smile TheoryIt can be seen that whenever the USA pushes the world financial market into a major recession or even through periods of development, the American currency tends to appreciate.

But what should we expect from here on out? Well, we must keep in mind that world economies have a cyclical rhythm, they slow down, lose momentum, and then pick up again, and so on, 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. And thus, analyze its behavior in relation to other world economies, this is the only way to predict the possible progression of the dollar using the The Smile Theory.

SUMMARY

We, from The Florida Lounge, believe in the acquisition of real estate in the United States as an excellent strategy to balance the investment portfolio, because besides being linked to the dollar, this investment generates profitability, beyond the simple exchange rate appreciation. And yet, because it is a real estate investment, it also protects the principal capital from inflation and in the long term, we can still experience interesting gains with the appreciation of the assets acquired.

In our content portal we have several articles talking about the history of real estate valuation in the USA as well as projections made by experts in the American real estate market.

Are you in doubt?

Now that you know a little more about the behavior of the dollar in times of crisis and in times of economic strength, we can help you understand the behavior of the real estate market and consider investing in vacation homes in orlando. To take advantage of all the tips we have brought to you and go even deeper, you can talk directly to our relationship agents. They are always happy to talk to you with any questions you may have about investing in Florida.

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