The U.S. dollar surged to a nearly two-year high against the basket of other currencies driven by a hawkish Fed. A strong dollar will lead to a rally in the stock market as it attracts foreign money from investors seeking dollar-denominated returns instead of their home currencies. Additionally, it provides an edge to the domestic-focused companies.
This is because energy cost in America decreases with a strong dollar, thereby lowering the industrial cost and improving profitability as well as the overall economy. Investors seeking to make a play from this trend could consider ETFs such as Invesco DB US Dollar Index Bullish Fund UUP, WisdomTree Bloomberg U.S. Dollar Bullish Fund USDU, iShares Russell 2000 ETF IWM and iShares Currency Hedged MSCI EAFE ETF HEFA.
Inside the Dollar Surge
The Federal Reserve raised the interest rates by 25 bps for the first time in three years and is expected to follow a more aggressive path in raising rates to fight the 40-year high inflation. Fed Chair Jerome Powell showed confidence that the American economy is strong enough to withstand a tighter monetary policy. The move indicates a a healthy economy and is expected to pull in more capital into the country and lead to the appreciation of the U.S. dollar (read: ETFs to Win & Lose on the Likely First Rate-Hike Since 2008).
The latest Fed minutes showed the expectations of multiple half percentage-point rate increases to control soaring inflation. Federal Reserve Governor Lael Brainard indicated an aggressive approach to shrinking the central bank’s balance sheet. He hinted that the central bank will start “to reduce the balance sheet at a rapid pace as soon as May meeting.” The current pricing suggests a 0.5% bps hike in May and a cumulative boost of 2.5% to the benchmark rates through the end of the year, from the near-zero level at the start of 2022.
Fed funds futures traders expect the Fed’s benchmark rate to rise to 2.60% by February from the current 0.33% According to the CME Group’s FedWatch, traders are betting on half-point moves higher in the Fed Funds rate at the next three Fed meetings in May, June and July.
Let’s now discuss the ETFs in detail below:
UUP
Invesco DB US Dollar Index Bullish Fund is the prime beneficiary of the rising dollar as it offers exposure against a basket of six world currencies. This is done by tracking the Deutsche Bank Long USD Currency Portfolio Index – Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities. In terms of holdings, Invesco DB US Dollar Index Bullish Fund allocates nearly 57.6% in euro and 25.5% collectively in the Japanese yen and British pound (see: all the Currency ETFs here).
The fund has so far managed an asset base of $993.2 million while seeing an average daily volume of around 1.8 million shares. UUP charges 78 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.
USDU
WisdomTree Bloomberg U.S. Dollar Bullish Fund is another way to play the rise in dollar directly. It offers exposure to the U.S. dollar against a basket of foreign currencies by tracking the Bloomberg Dollar Total Return Index. WisdomTree Bloomberg U.S. Dollar Bullish Fund exhibits strong negative correlations to international equity and bond portfolios.
WisdomTree Bloomberg U.S. Dollar Bullish Fund has…
