Why the US dollar’s “crooked smile” could upend asset allocation
"Not all smiles are straight. Some bend under the weight of what they’ve seen."
— Unattributed
The Dollar Smile Theory posits that the world’s reserve currency tends to appreciate both when the US economy is weak (as investors take flight to quality) and when it is strong (as investors become optimistic about US growth). The theory also holds that the dollar weakens in the middle part of the distribution (the bottom of the smile) when US growth moderates relative to the rest of the world ( Figure 1 ). During April 2025, when volatility gripped markets amid tariff concerns, the USD sold off even as stocks plunged, and odds of a US recession rose. To understand why the theory did not hold and what it means for markets from here, it is worth considering the perspective of foreign (ex-US) asset allocators.
