The dollar goes up at either end—for extreme good or bad.
Photo: Getty Images/iStockphotoInvestors 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.
In March, the dollar hit one end of the smile—the bad one—as investors grew increasingly concerned that the Covid-19 pandemic would threaten the U.S. economy. The rally in the U.S. currency was “nothing short of spectacular,” according to a recent report from New York-based bank Brown Brothers Harriman.
The dollar index, which measures the value of the dollar relative to other currencies, rallied 8.3% between March 9 and March 20, according to Bloomberg, as fear drove a flight to safety. “If this is the end of days where do you want your money?,” says Marc Chandler, managing director at New York-based currency dealer Bannockburn Global Forex LLC. “The dollar is a safe haven; it has the biggest economy, the strongest bonds, and the largest military.”
Foreign investors who borrow dollars to buy U.S. securities may have helped fuel the dollar’s rally, Mr. Chandler says. As global markets slid, at least some of those investors were likely eager to dump their holdings and quickly pay back their loans, creating additional demand for the U.S. currency globally.
The situation reversed on March 23 as the Federal Reserve cut interest rates and implemented a bond-buying program to help avert financial Armageddon. The dollar started to drop and money flowed back into stocks and other riskier assets.
Mr. Chandler says the Fed’s actions were far greater than those of other central banks, which will likely mean a faster U.S. economic rebound. In turn that would mean a dollar smile from the other side—the good side.
“If the Fed’s aggressive response makes it the first to normalize the economy then we also get a strong dollar,” he says.
Mr. Constable is a writer in Edinburgh, Scotland. He can be reached at reports@wsj.com.
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