Definitive Short Dollar ETF Guide: Inverse USD ETFs

by on December 10, 2009 | Updated November 1, 2012 | ETFs Mentioned:

The steady decline of the U.S. dollar has been one of the major stories of the second half of 2009, with a “perfect storm” of economic conditions sending the greenback to new lows against many of its major rivals. While a declining dollar isn’t nearly the problem that some make it out to be – a weak currency actually makes U.S. imports more attractive to foreign consumers – worries about a continued slide have all walks of investors, both hedgers and speculators, looking for efficient ways to achieve short exposure to the dollar. There are a number of ETFs that do just that, with each offering a unique risk and return profile.

Drivers Of A Falling Dollar

Swiss FrancBecause exchange rates are influenced by a wide variety of often-competing factors, attributing rises and falls in currencies to a particular trend is difficult. Some of the factors that have weighed on the U.S. dollar in recent months include:

  • Record Low Interest Rates: To stimulate economic activity, the Federal Reserve cut benchmark interest rates to nearly zero in 2008, and has indicated that it will continue to depress rates for the foreseeable futures. With rates at record lows, investments in fixed income securities are relatively unattractive to foreign investors, leading to reduced demand for U.S. dollars.
  • End Of “Home Country Bias”: Following extreme volatility in U.S. equity markets in recent years, investors have begun to question strategies that call for large portfolio allocations to U.S. stocks. As foreign equity ETFs have surged in popularity (they’ve seen cash inflows of almost $30 billion in 2009, compared to more than $25 billion in outflows from domestic equity funds), demand for foreign currencies has surged, sending the dollar lower.
  • Reserve Currency Questions: Foreign countries have traditionally held a significant portion of their reserves in U.S. dollars, creating a floor on demand for U.S.-denominated securities. But in recent months concerns over the dollar’s future as the default reserve currency have surfaced, and many governments have begun diversifying their reserve holdings into hard currencies (i.e., gold).

ETFdb Pro members can learn more about the drivers behind currency ETFs in our ETFdb Category Report [for more ETF analysis, make sure to sign up for our free ETF newsletter or try a free seven day trial to ETFdb Pro]

For investors looking to gain inverse exposure to the U.S. dollar, there are two general strategies: 1) the “basket approach” – investing in a number of foreign currencies and 2) the “single currency approach” – investing in a specific currency that one believes will appreciate relative to the greenback.

Diversified Short Dollar ETFs

For investors interested in diversifying their short dollar exposure across a basket of foreign currencies, the PowerShares DB USD Bullish (UDN) and WisdomTree Dreyfus Emerging Currency Fund (CEW) are two popular ways to play a dollar decline without investing in a single foreign currency. These ETFs invest in a basket of currencies which helps to spread the risk around. UDN invests in developed market currencies including the Euro, Japanese Yen, and the British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. These currencies stand to benefit due to their roles as backup reserve currencies that usually play second fiddle to the greenback (see more information about CEW on its fact sheet page).

Meanwhile, CEW takes an emerging market approach to establish a basket of currencies that hedge the dollar’s decline. Currencies in this fund include the Mexican Peso, Turkish New Lira and the Chinese Yuan, all of which stand to benefit from the trend of investment moving to emerging market countries where growth is predicted to outpace the developed world for the near future. Both UDN and CEW could benefit if more governments put their monetary surpluses in more diversified currency holdings instead of just U.S. Dollars. It is estimated that around 63% of all the world’s forex reserves are held in U.S. Dollars. If just a tiny bit of that $2.6 trillion found its way into other currencies it could give a big boost to diversified currency funds that bet against the U.S. Dollar.

For a complete look at how UDN and CEW stack up, see this feature article.

Single-Currency ETF Options

Emerging Market Currency ETFs
Ticker Currency
CYB Chinese Yuan
BZF Brazilian Real
ICN Indian Rupee
XRU Russian Ruble
SZR South African Rand

Both WisdomTree and CurrencyShares offer exchange-traded products providing exposure to the value of various world currencies relative to the dollar. While these products are similar in many respects – they track all of the same exchange rates – there are a few not-so-small differences that could have a major impact on returns delivered to investors. CurrencyShares products are structured as grantor trusts, while WisdomTree products are exchange-traded funds.

This seems like a minor distinction, but it can have a big impact on the way currency products are managed and taxed. The details on the ramifications of these structural classifications are a bit complex, but the en result is that WisdomTree products generally do a better job of spreading credit risk across a number of counterparties and can be more tax efficient when held for more than a year.

Single currency ETFs can be broken down into two main categories: emerging and developed currencies. Similar to equities, emerging market currencies generally carry more risk since government intervention in financial markets can be both more common and produce more extreme results [Download 101 ETF Lessons Every Financial Advisor Should Learn].

For those who think increases in cash flows to emerging markets will send currencies higher in coming years, there are several ways to gain exposure to various currencies (outlined in the table above). For those who think the dollar’s decline will come at the hand of its developed rivals, single-currency options include:

  • WisdomTree Dreyfus Euro Fund (EU): As the perennial second largest reserve holding, the euro stands to benefit greatly from a drop in the dollar, especially if the dollar becomes so volatile that countries start pegging to the euro instead of the dollar, or if major commodities such as oil and gold start trading in euros as well as dollars. If this happens, look for euro holdings to spike upwards. If the euro zone can truly become a cohesive economic unit and somehow get European countries like Great Britain and Norway to join the monetary union, it can become a real rival to the U.S. dollar. However, replacing the dollar as the destination in ‘flight to safety’ times seems unlikely. Unless of course foreign governments continue to lose faith in the dollar, as we’ve seen in China recently. For more information about EU, check out its technical analysis page.
  • WisdomTree Dreyfus Japanese Yen Fund (JYF): While most of Asia has rebounded nicely from the recent downturn, Japan remains mired in an economic downturn that is now threatening to produce another “lost decade.” A strong yen has been blamed as one of the culprits for the prolonged recession, causing a slump in demand for Japanese exports. As the government gears up to implement its third major stimulus package in the last year, many investors believe the yen may be forced back down to revive the country’s export market. See more about JYF on its fundamentals page.
  • Rydex CurrencyShares Australian Dollar Trust (FXA): In the fourth quarter of 2009, Australia became one of the first developed economies to begin raising interest rates, evidence of a successful recovery effort down under. If subsequent rate increases don’t derail the stock markets, Australia could see rates rise well above those in the U.S. in 2010. See technical analysis of FXA here.
  • Rydex CurrencyShares Canadian Dollar Trust (FXC): Canada’s “loonie” could be hurt if the U.S. dollar depreciates too significantly (since a sizable portion of trade is done with the U.S.), but a slow steady depreciation of the American dollar could boost the commodity sector of the Canadian economy (which is focused on oil, natural gas, and timber, all of which are in low supply in much of the developing world). See charts of FXC here.

More Short Dollar Currency ETFs

For the investor that truly believes in the dollar’s collapse, there are a number of leveraged currency funds that offer ways to amplify daily movements in exchange rates.

For those looking to avoid fiat money altogether, gold and silver ETFs may be attractive options to safeguard your wealth from the ravages of inflation (see our guides to gold ETFs and silver ETFs for a complete rundown). For more actionable ETF investment ideas, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.