Dollar Strengthens as Recession Fears Fail to Dent its Resolve

The US dollar has strengthened in recent times, and according to the Dollar Smile Theory, it may continue to do so even if the Fed tightens monetary policy aggressively enough to put the economy into a recession.

This theory suggests that the greenback can strengthen under two contrasting scenarios: when economic conditions are strong and when global or domestic conditions deteriorate sharply.

Currently, markets are pricing in a federal funds rate increase of at least 75 basis points, which is likely to add downward pressure on the EUR/USD pair.

The spread between 10-year and 2-year US Treasury yields is approaching inversion, which has historically been associated with elevated recession risks. However, this dynamic does not appear imminent given the strength of the labor market, substantial investment in artificial intelligence, rising productivity, the wealth effect, and improving PMI readings.