In times of recession, the US currency operates on the same pattern. • ForexTalker

In times of recession, the US currency operates on the same pattern.

3 min read

The global economy is cyclical. And if during periods of expansion or recovery of GDP U.S. $ allows other competing currencies to take the initiative, then in times of recession pulls a blanket over itself.

The blame for the importance of the US economy and that colossal role, played by greenback in international settlements, foreign exchange reserves, Forex and cross-border lending volumes. In times of global downturn, investors forget about the impact of European macro statistics on the euro, on the impact of Bank of Japan monetary policy on the yen, on the pressure of political risks on the British pound. Their eyes are turned to one single currency. US dollar.

curious, that in times of recession, the greenback behaves according to the same pattern, which formed the basis of the developed currency strategist Morgan Stanley Stephen Jenn theories «dollar smiles». In the dynamics of the USD index, three stages are clearly traced:

  • buy it, since the American economy is on its feet;
  • sell amid aggressive monetary expansion by the Fed
  • and buy again because of hopes, that the recovery rate of US GDP will exceed the growth rate of peers in other countries.

The result is a picture, very similar to a smile.

Dollar smile

Consider the dynamics of the USD index in more detail. At the first stage greenback is very populardue to strengthUS economy. She looks better than the rest, which increases the demand for US stocks and bonds and leads to an increase in investment flows to the States. In 2019 and early 2020, the USD index really grew thanks to an impressive S rally&P 500 and high demand for treasuries due to trade wars.

The first stage ends with the correction of US stock indices, which ultimately leads to the transfer of the stock market under control «bears». The dollar peaks, «left side smiles», thanks to the flight of investors to quality. It serves as the main currency of refuge. At the end of February due to coronavirus S&P 500 moved to territory «bears» in record time – within 16 days. The direct correlation of the USD index with the stock index has been reversed. At the first stage of the previous world economic crisis, greenback strengthened by 24 from March to November 2008%.

The dynamics of the dollar and US GDP

In the second stage, which Stephen Jen calls «bottom of the smile», take place greenback sales due to aggressive Fed monetary expansion. Federal funds rate cuts to near zero, unlimited purchase of assets and a large-scale fiscal stimulus from the White House launched a downtrend in S&P 500 at the end of March. Rising demand for risky assets helps eliminate long speculative greenback positions. A very similar situation occurred in late 2008, when the Fed is using aggressive monetary expansion, including running QE on $700 billion, tried to deploy «bearish» the trend of the American stock market and knock off arrogance from greenback fans. For a while I even got a feeling, that he did it – USD Index Fell By December.

Dollar and S dynamics&P 500

In the third stage dollar returns to growth again, as investors start to count, what US economy will recover faster than its foreign counterparts. US stocks look cheap, and low cost of borrowing, Fed’s ultra-soft monetary policy, GDP gradually rising from its knees and hopes for growth in corporate profits contribute to the return of non-residents’ interest in assets issued in the United States.

If you follow the theory «dollar smiles», then currently you need to actively buy greenback. However,, is not a fact, that the US economy will be able to recover faster than China’s global GDP, and the Fed’s strong desire to prevent strengthening «American» can seriously change the rules of the game.