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Short the Euro with These Inverse ETFs

Zacks Equity Research

Though the Euro zone emerged out of a two-year long debt crisis in the second quarter of last year, it has failed to sustain the wining momentum in 2014. The region has so far been dragging its feet with its second largest economy, France, being stalled and the third largest economy, Italy, already slipping into a recession. Fresh banking woes in Portugal and shrinkage in German GDP in Q2 have also taken the shine off Europe investing (read: Where Will Europe ETFs Go After Portugal Banking Woes?).

Feeble recovery and deflationary worries kept a firm lid on the common currency – euro. The region’s annual inflation slipped to a 5-year low in July. The number was 0.4% in July, down from 0.5% in June and 1.6% in July of 2013. Negative annual inflation rates were noticed in Greece, Portugal, Spain and Slovakia.  Notably, the ECB follows a directive to maintain inflation rates close to 2% per year.

Quite expectedly, the European Central Bank (:ECB) will react to this situation. In early June, the ECB announced a cut in its benchmark rate to 0.15% from 0.25%. Also, the bank introduced a negative deposit rate (-0.1%) which was previously held at zero percent, the first for a major central bank.
Since this cut by the ECB, several investors have started to question the course of the common currency, and many have sold off the euro against the greenback as of late. Investors should note that although the U.S. is stumbling this year, better corporate earnings, improving housing data and the potential end of QE program strengthened the dollar in the past months (read: Negative Interest Rates Put These European ETFs in Focus).
If these were not enough, the ongoing tension between Russia and the West on the Ukraine issue and the resultant sanctions hardly hit European nations. The export-centric German economy appears predominantly susceptible to the Russia sanctions since roughly 30% of the European Union exports to Russia come from that country (read: Russian Food Import Ban Takes a Bite Out of These Agricultural ETFs).

All these issues left the Euro struggling. The euro fell to 9-month lows against the dollar on August 12, as investors prepared themselves for another round of slowdown in the Euro zone following sluggish German sentiment surveys.

ETF Impact
CurrencyShares Euro Trust (FXE) – designed to track the performance of the euro against the dollar – lost about 2.9% this year.  We are maintaining our Strong Sell recommendation on this euro ETF. As a result, investors who are bearish on the euro right now, definitely for a valid reason, may consider a near-term short on the space.

Fortunately, ETFs offer several options to investors to accomplish this task. Below, we highlight a few of the options in the inverse ETF space. These ETFs profit when the euro declines and may be suitable for hedging purposes against the fall in the currency.

ProShares Ultra Short Euro ETF (EUO)

This leveraged ETF was launched in November 2008 and looks to provide twice the inverse exposure to the performance of euro versus the U.S. dollar on a daily basis.

The product has amassed over $461 million in AUM. However, given its style, the ETF charges a hefty annual expense ratio of 95 basis points.

The fund has added about 4.4% on a year-to-date basis (as of August 18, 2014). Investors could book more profits off this fund, should the euro continue to struggle.

Market Vectors Double Short Euro ETN (DRR)

This is an exchange-traded note issued by Morgan Stanley. The product seeks to track the performance of the Double Short Euro Index. For every 1% decline in the euro relative to the greenback, the Index normally gains 2%.

The choice is an overlooked one with just $37 million in AUM. The product charges an expense ratio of 0.65% a year. On a year-to-date basis, the product has advanced about 5.9% (as of August 18, 2014).

Where Will Euro Go From Here?

At present, the future course of the Euro zone is uncertain. A recent study by the European Central Bank guidance indicates that Euro zone inflation has almost approached a ‘trough’ and will be going up in the next few years.

On the other hand, Saxo Bank notified that Germany may fall into recession by the end of this year and Europe might see Japanese-style deflation.  In fact, in June, a Bank of Japan policymaker, also expressed the same concern over the European inflationary scenario.

In a nutshell, whatever be the case, the region is far from being stable and still needs time and stimulus. With GDP of dominant nations reeling under pressure, the pressure on euro could remain in the coming days as an appreciating euro will mar the export profile of the region. If the ECB comes up with more stimulus packages, the currency will be threatened once again.

Given this, investors can ignore the euro at the current level or book profits out of some inverse products. However, as a caveat, both inverse products are volatile and suitable only for short-term traders if there is more euro weakness.
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