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Record-Low Dollar Volatility Puts These ETFs in Focus

Zacks Equity Research

Rough recovery of the U.S. economy and the Fed’s recent dovish comments over interest rate policy set the backdrop for the greenback’s future trading sessions. Per Bloomberg, the dollar is seeing its longest losing streak since April this year. Expectations for price volatility in the dollar-yen currency pair slipped to a record low.

The Fall in Detail

While the Fed cut its QE stimulus by another $10 billion to $35 billion a month, its dovish commitment to keep the interest rates at rock-bottom level for a ’considerable time’ hit the value of U.S. dollar. Even if the Fed wraps up its massive stimulus program this fall, it is unlikely to raise its interest rates before Q1 of 2015.

However, the Fed now expects interest rates at the end of 2015 to hit 1.25%, up from 1.0% projected in March. The key rate is likely to go up to nearly 2.5% at the end of 2016, higher than previously projected 2.25%. Nonetheless, the Fed has lowered the longer-term rate forecast to 3.75% from about 4%.

Not just the highly accommodative monetary policy, the FOMC also trimmed the U.S. GDP growth estimate for this year to justify the contraction in Q1. Growth this year is now expected in the 2.1−2.3% range, down from the March level of 2.8−3%. With this, the Fed’s growth forecast matches the lately cut projections from the World Bank and IMF (read: Play a Rising Dollar with These ETFs).

In any case, the U.S. economy had a shaky start to this year with a cold snap taking away all the warmth from Q1. Since then, the economy is striving to reach last year’s height, but a sluggish housing recovery, faltering consumer confidence, a listless manufacturing sector and still-not-strong job reports have held back full-fledged recovery. All these have reined in the dollar’s price.

Market Impact

To reflect this uncertainty, the U.S. currency retreated against all except one of its 16 key equivalents last week. Most other developed currencies like the Australia dollar, New Zealand’s dollar, Canadian dollar and British pound advanced last week, per Bloomberg.

Australia and New Zealand’s currency might have got the boost from the impressive manufacturing gauge of China which is the duo’s major trading partner.

Given the indecisive economic fundamentals, the bullish trend in the greenback will likely be arrested at least for the short term. Two ETFs having a bullish view on the U.S. dollar − PowerShares DB US Dollar Bullish Fund (UUP) and WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) lost about 0.37% and 0.32%, respectively, last week (see: all the Currency ETFs here).  

Investors seeking to make money from the recent slump in the greenback could consider a short USD ETF option – PowerShares DB US Dollar Bearish Fund (UDN). However, this option also does not appear foolproof as this fund includes the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc with euro taking as much as 57.6%.

With the ECB recently announcing an easy monetary policy and introducing a negative deposit rate, Euro is expected to be a laggard in the coming days. British pound, which was rushing up the currency ladder, fell against the dollar though it is still a top performer in the ETF world for the time being. Only, the likes of Canadian dollar will stand to gain in the wake of a weakening greenback (read: 2 Ways to Short the Dollar with ETFs).  

Bottom Line

The greenback might weaken further as the second look at Q1 U.S. GDP could be harsher. Market participants believe that the U.S. economy skidded about 1.8% in Q1 against the earlier estimated decline of 1.0%.

Overall, the data coming out each day is somewhat fragile and will go completely against the U.S. dollar. Hence, we suggest investors stay on the sidelines when it comes to investing in bull dollar ETFs with short-term notion (read: Where Will Global Currency ETFs Go in 2014?).

However, the long-term aspect is quite bullish for the dollar especially given that the currency is set to rule once the Fed closes its stimulus program. Investors with high risk tolerance can also buy bull dollar ETFs like UUP on its recent dip, but that should be with a long-term view.

In any case, UUP has a Zacks ETF Rank of 2 or Buy rating with a Medium risk outlook so it could be an interesting choice for investors looking at this space right now for the long haul.

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