U.S. Dollar ETF On A Roll

by on December 18, 2009 | ETFs Mentioned:

More much of the second half of 2009, one of the overarching themes has been continued weakness in the U.S. dollar, as a perfect storm of economic and political factors combined to push the greenback continually lower against major rivals. But once the calendar turned to December, the tables turned as well, and the U.S. currency took off on a furious rally that has seen it reclaim much of the ground lost over the previous months.

Dollar ETFs Have Been On A RollThe reasons for the dollar’s impressive rebound are as numerous as the factors that drove it lower in recent months. Weakness in the euro has boosted the dollar’s value, as signs of potentially serious trouble in Europe have emerged in recent days. Several major ratings agencies downgraded sovereign Greek debt, a reflection of the deteriorating fiscal situation in the euro zone country. “The downgrade reflects concerns over the medium-term outlook for public finances given the weak credibility of fiscal institutions and the policy framework in Greece,” said Fitch, one of the agencies to downgrade Greece. “The lack of substantive structural policy measures reduces confidence that medium term consolidation efforts will be aggressive enough to ensure public debt ratios are stabilized and then reduced over the next three to five years.”

In addition to pummeling Greek stocks, the news sent the euro lower in consecutive sessions. And while the developments in Greece are certainly troublesome, it should be noted that Greece GDP accounts for only about 2% of the euro-zone total in 2008. “In the grim event of a default by Greece, a bailout from other euro zone members is seen as easily affordable,” writes Katie Martin.

Earlier in the week, the Austrian government moved to nationalize the country’s sixth-largest bank, a development that weighed not only on the euro but the currencies of Central and Eastern Europe nations as well. The move raised questions as to how Western Europe economies will finance a recovery, and increased the likelihood that developed economies will have to withdraw from Eastern Europe.

Elsewhere in Europe, disappointing retail sales prompted worries about Britain’s economy, sending the pound lower against the dollar. ETFdb Pro members can read about all the drivers of currency ETFs in our ETFdb Category Report (if you’re not a Pro member yet, sign up for a free trial or read more here).

Beyond Europe

Drivers of a higher dollar extend far beyond Europe. In Japan, the economy is yet to show any signs of a true recovery, resulting in the third major stimulus plan in the last year. Some of the blame for the sputtering economy falls on a strong yen that has made the country’s exports unattractive to foreign consumers. The government recently pressured the Bank of Japan to take actions necessary to weaken the yen, including slashing the benchmark interest rate beyond its already historic lows.

U.S. Dollar ETFs

The majority of currency ETFs available to U.S. investors offer exposure to foreign currencies, essentially allowing investors to bet against the dollar. But there are several funds that tend to rise when the dollar strengthens:

PowerShares DB U.S. Dollar Index Bullish (UUP)

USDX Components
Euro 57.6%
Yen 13.6%
Pound 11.9%
Cad. $ 9.1%
Krona 4.2%
Franc 3.6%
As of December 17

This fund is based on the Deutsche Bank Long US Dollar Futures Index, a rules-based benchmark composed of long USDX contracts. These contracts are designed to replicate the performance of being long the U.S. dollar against a basket of developed currencies, including the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc. Although UUP has significant dollar exposure relative to all of these currencies, its biggest allocation is against the euro.

After losing more than 10% through the first 11 months of the year, UUP has recovered to gain 4.3% in December as the dollar has enjoyed a broad-based resurgence.

ProShares UltraShort Euro (EUO) and UltraShort Yen (YCS)

These leveraged currency ETFs are designed to deliver daily results that correspond to twice the inverse exposure of the daily performance of the U.S. dollar price of the euro and the yen. The dollar has gained significant ground on both of these rival currencies this month, sending EUO up 10% this month and YCS up almost 8%.

“Indirect” Dollar ETFs

Because most commodities are priced in U.S. dollars around the world, these assets tend to rise when the dollar falls and fall when the dollar rises. As such, inverse commodity ETFs tend to appreciate when the dollar strengthens. These funds include:

  • PowerShares DB Commodity Short ETN (DDP)
  • PowerShares DB Agriculture Short ETN (ADZ)
  • PowerShares DB Short Gold ETN (DGZ)

Disclosure: No positions at time of writing.