I recently returned from our 8thAnnual Inside ETFs conference in Florida, where I had the privilege of moderating a panel titled, “Currencies in the Age of Infinite Quantitative Easing.”
The timing for the panel was perfect. It was held on Jan. 27, just five days after the ECB’s 1 trillion euro quantitative easing announcement, and 12 days after the Swiss National Bank shocked the markets by doing a 180 degree U-turn to scrap its three-year-old euro ceiling.
My takeaway from the panel was that even though the market consensus is calling for continued dollar strength in 2015, the currency markets are in disarray, and the smartest minds in the industry differ on their currency outlook.
Some panelists were bullish on the dollar against certain currencies—notably the euro. But at the same time, many were bearish (or neutral) on the dollar against other currencies, such as the yen.
This makes sense. Currencies are traded in pairs, so a long bet on one currency means you’re betting against another currency. So, you’re inherently always long one currency and short another, relative to each other.
That’s why I get annoyed when I hear market pundits on TV telling us that they’re long the euro, franc, renminbi, yen and the dollar. I would ask, what is your base currency, and what countercurrencies are you shorting these long currency bets against if you’re also long the dollar?
Current ETF Options
As ETF investors, we’re currently forced to take either a full “long” or “short” direction on the U.S. dollar.
Of the 37 existing currency ETFs, 29 are short-dollar funds that “go long” a foreign currency, or a basket of currencies, against the U.S. dollar. There’s only a handful of long-dollar strategies that short currencies against the dollar.
But is everyone really bullish or bearish on the dollar against all currencies, or is the dollar outlook increasingly becoming a mixed bag, depending on the currency?
Where’s our actively managed long/short dollar ETF that goes both long and short the dollar against different currencies, where the manager also has discretion about weightings given to each currency pair?
I’m talking about an “absolute return” currency fund.
Existing Mutual Funds
The mutual fund world has a few such funds, including the Merk Absolute Return Currency Fund (MABFX) and the John Hancock Absolute Return Currency Fund (JCUAX).
In the ETF landscape, the Pimco Foreign Currency Strategy ETF (FORX | C-30) is probably the closest to fitting that bill. FORX has the capability of shorting a currency against the dollar—it currently has a short-yen position—but by and large, it’s a “short-dollar” fund.
We certainly have passive long/short ETFs based on carry strategies, such as the iPath Optimized Currency Carry ETN (ICI | D-49) and the PowerShares DB G10 Currency Harvest Portfolio (DBV | C-48). But interest-rate differentials are only one part of the equation, especially in today’s volatile currency landscape.
One filing worth noting is from Cambria, the issuer behind the $213 million Cambria Shareholder Yield ETF (SYLD | B-44). According to filings, the Cambria Global Income and Currency Strategies ETF (FXFX) will be an actively managed long/short dollar ETF, based on G-20 currencies.
The Case For A Long/Short Dollar ETF
One of the panelists pointed out that we’re in a global currency war. Not intentionally, but as a byproduct of central banks attempting to stimulate their economies in the face of little to no fiscal help from their respective governments.
This makes other central banks intervene to keep a lid on their currencies from appreciating out of control. And as we witnessed when the SNB flip-flopped on its policy in early January, we can be blind-sided by volatility overnight.
The market consensus is calling for the Federal Reserve to begin raising rates in the summer or fall of 2015. But the U.S. dollar has already surged above levels not seen since the 2008 financial crisis against some currencies.
I’m now hearing calls for the euro to hit parity with the dollar. That could certainly happen, but that’s also assuming the Federal Reserve will sit back and allow that to happen.
I question just how much the Federal Reserve can “tighten” and normalize rates in such a surging dollar environment just when most developed central banks are easing as developed markets are mired in deflationary pressures.
Warren Buffett recently addressed this issue, going so far as saying the Federal Reserve should put off raising rates in the current strong dollar environment, so as not to choke off exports and growth.
What if for some reason the Fed decides to become less hawkish than expected? What will that do to commodity prices and currencies of commodity-producing countries that have been pummeled?
I don’t have a clue what the Fed will do. But I’m not sure I’d want to be fully long the dollar against all currencies, either.
Even the yen seems to have found a floor, if only temporary, at around 120 yen/dollar after the Bank of Japan surprised with additional stimulus in late October. Still, paradoxically, the yen tends to rise when Abenomics loses steam or the risk-off trade comes back into vogue.
Clearly, the biggest uncertainty with actively managed funds is that you’re putting your faith into a manager’s ability to select the right currency pairs. But in today’s fast-changing currency environment, it’s hard to be fully bearish or bullish on the U.S. dollar.
With so many forces at play, I think there’s a case to be made for an absolute-return currency ETF.
At the time this article was written, the author held no positions in the securities mentioned. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.