Thoughts on the Market – "Why the U.S. Dollar Still Smiles"

Host: Andrew Watrous, G10FX Strategist, Morgan Stanley
Date: September 5, 2025

Episode Overview

In this episode, Andrew Watrous revisits the enduring “Dollar Smile” framework, explaining how the US dollar typically responds to shifting global growth conditions. Contrary to recent skepticism, Watrous argues the framework remains valid, detailing why the dollar still acts as a safe haven—even when uncertainty originates in the US or amid changing global financial structures. He also discusses the significance of the dollar’s sharp decline in 2025 and offers a forward-looking view on its potential path into 2026.

Key Discussion Points & Insights

1. The Dollar Smile Explained

• [00:30] Watrous introduces the “Dollar Smile” – a model created at Morgan Stanley in 2001 to understand the US dollar’s performance under various global growth scenarios.
  • Left Side of the Smile: The dollar rises when global growth is weak and investors seek safety in US assets.
  • Right Side of the Smile: The dollar also rises when US growth notably outpaces the rest of the world, attracting capital.
  • Middle (Bottom) of the Smile: The dollar weakens during robust, synchronized global growth, as investors pursue riskier non-dollar assets.

2. Challenging and Defending the Smile

• [01:40] Watrous notes recent arguments claiming the left side of the smile is “broken,” with critics pointing to:

  • The dollar potentially not rallying if the US itself is the shock’s source (politics, trade wars).
  • Elevated US interest rates or shifts in global asset holdings potentially muting the traditional safe-haven flows.

• [02:15] He rebuts this skepticism with fresh data and examples.

3. The Smile Holds Up – Quantifying the Framework

• [02:30] Morgan Stanley analyzed economic surprise indices—measuring whether economies outperform or underperform forecasts—to test if the Dollar Smile still works.
  • Weak US and Global Growth:
    • “The dollar rises on average about 0.8% per month, which is over the last 20 years.” (Watrous, 02:45)
  • US Outperformance:
    • “The dollar goes up even more, about 1.1% on average per month.” (Watrous, 03:00)
  • Synchronized Global Growth:
    • “The dollar tends to decline on average a little bit, about 0.1% on average per month.” (Watrous, 03:12)

4. Recent Real-World Examples

• Trade Tensions & Policy Uncertainty (2018-2019):
  • Despite US-driven shocks, “the left hand side of the dollar smile worked back then, even though the concerns were driven by US factors.” (Watrous, 03:20)
• Geopolitical Crises (June 2025):
  • “When geopolitical tensions spiked between Israel and Iran... the dollar surged, investors fled to safety, and the dollar delivered.” (Watrous, 03:32)
• Tariff Announcements (April 2025):
  • The dollar “dipped initially after the first tariff announcements, but then it fell even more after those tariff hikes were paused. …What weighed on the dollar this spring was policy unpredictability in the US which led investors to reduce their exposure to US Assets…” (Watrous, 03:54)
• Conclusion:
  • “The dollar can still act as a safe haven despite changing patterns... even when the US Itself is the source of global concerns.” (Watrous, 04:16)

5. The Dollar’s Recent Decline & Outlook

• [04:27] Watrous notes, “the US dollar dropped about 11% against other currencies in the first half of this year. This was the biggest decline in more than 50 years and it ended a 15 year bull cycle for the US dollar.”
• Looking ahead:
  • He anticipates continued weakness through 2026 due to anticipated Fed rate cuts and lingering uncertainty.
  • However:
    • “Even with all that, we think our framework holds—when markets wobble, remember, the dollar will probably greet volatility with a smile.” (Watrous, 04:50)

Notable Quotes & Moments

• On the Dollar Smile Framework:
  • “Picture a smile shaped curve… the dollar rises when global growth is concerningly weak… and when US Growth outperforms…” (Watrous, 00:49)
• On Empirical Results:
  • “We found that when growth in the US and outside the US are both surprisingly weak… the dollar rises on average about 0.8% per month…” (Watrous, 02:40–02:50)
• On Safe Haven Dynamics:
  • “These episodes… show that the dollar can still act as a safe haven despite changing patterns of global asset ownership…” (Watrous, 04:15)
• On the Dollar’s Future:
  • “When markets wobble, remember, the dollar will probably greet volatility with a smile.” (Watrous, 04:50)

Key Timestamps

| Time | Segment | |---------|----------------------------------------| | 00:30 | Introduction to the Dollar Smile | | 01:40 | Recent criticisms of the framework | | 02:30 | Morgan Stanley's empirical analysis | | 03:20 | Examples from 2018-2019 and 2025 | | 04:27 | Dollar’s major decline in 2025 | | 04:50 | Forward-looking perspective |

Summary

This episode makes a compelling case that the “Dollar Smile” framework remains relevant, even as global financial structures evolve and US-centric shocks occur. Empirical evidence and real-world examples reinforce that the US dollar still tends to rise during global duress or US outperformance, and weakens when growth is strong worldwide. Looking ahead, while the dollar may trend lower, it retains its time-tested safe haven role—ready to “greet volatility with a smile.”