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Impact of a Stronger Greenback if Dollar Rallies

This article was originally published on ETFTrends.com.

Up about 4% year-to-date, the Invesco DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) is one of this year's best-performing major currency ETFs. However, some market observers remain concerned about the impact of a stronger greenback.

UUP tracks movements against a basket of currencies including euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. UUP tracks the Deutsche Bank Long USD Currency Portfolio Index – Excess Return Index.

“A stronger U.S. economy relative to international economies has contributed to the dollar rally, while trade tariff rhetoric has pushed investors to seek out the currency as a safe haven asset,” said Michael Binger, senior portfolio manager at Gradient Investments, in an interview with CNBC.

Dollar Benefiting From Fed

The dollar is benefiting from, among other factors, interest rate tightening by the Federal Reserve. The Fed has boosted borrowing costs twice this year with plans for two more rate hikes before the end of 2018.

Rising inflation in the U.S. could be a catalyst for additional rate hikes, which could spark the dollar higher. However, some market observers believe other global central banks are out of ammunition for easy monetary policy, meaning dollar rivals, such as the euro and yen, could be due for some upside as well.

Related - Gold ETFs: Waiting on Dollar Declines

The stronger dollar is also a drag on large-cap multi-nationals that generate significant portions of their revenue in markets outside the U.S., likely explaining, in part, why small-cap stocks and ETFs are thriving this year. A stronger U.S. dollar and concerns over weaker global growth also pushed investors toward smaller company stocks that tend to earn most of their money from a still growing domestic economy.

“U.S. multinationals will also get squeezed. Companies that generate revenues overseas have to convert international sales back into U.S. dollars, reducing the overall amount,” according to CNBC. “Longer term, the dollar should move lower than where it is today, due to the large U.S. trade deficit and mean reversion of international interest rates and economic growth.”

Traders considering a bearish position on the dollar can consider the Invesco DB US Dollar Index Bearish (UDN) , an inverse though not leveraged bet against the greenback.

For more information on the USD, visit our U.S. dollar category.