Bull Dollar ETFs Beating Market Turmoil

May 10, 2022

A small portion of the ETF markets betting on the U.S. dollar’s continued strength against other currencies is one of the few asset classes still producing returns in the panic-ridden past few weeks. 

The $1.1 billion Invesco DB U.S. Dollar Index Bullish Fund (UUP) and nearly $500 million WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) have produced returns of 4.16% and 3.82%, respectively, in the past month, beating benchmarks for the S&P 500, aggregate bonds and a diversified basket of commodities. 
 

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UUP and USDU have returned 8.4% and 6.8%, respectively, year to date, beating the iShares Core U.S. Aggregate Bond ETF (AGG)’s 9.56% decline and the SPDR S&P 500 ETF Trust (SPY)’s 16% loss as of Tuesday. 

Fed Hikes An Advantage 

Bullish dollar ETFs work by holding futures tracking the U.S. Dollar Index in a long position against foreign currencies such as the euro, yen, British pound. The returns come if the dollar continues to gain relative to the shorted currencies. 

Inflation would normally cause a currency to lose value, but inflation is high across developed economies trying to manage the disruptions of COVID-19. The year-over-year inflation rate in the United Kingdom for March was 7%. Germany, which is the European Union’s largest economy, most recently posted a 7.8% annualized inflation reading. 

A higher inflation rate implies that a central bank is going to raise rates more aggressively to curb it. The difference is the Fed’s two straight rate hikes and tough talk on inflation versus comparable central banks, said Chris Vecchio, a senior strategist at DailyFX. 

The Fed has telegraphed its intentions to hike for several months, and bond yields rose to price in those expectations, while other central banks haven’t been as aggressive. Japan’s central bank has pledged ongoing support for its economy, saying in recent weeks that it will buy an unlimited number of 10-year bonds to support a yield cap. 

“For the dollar, as US Treasury yields have gone up, its counterparts have basically run into a ceiling more or less,” Vecchio said. “That has greatly increased the appeal of the dollar against not just the yen, but a basket of major currencies around the world.” 

The difference in central bank attitudes has made dollar ETFs outperform versus funds tracking the euro, yen and British pound. 
 

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Bull Rally’s Possible End 

The dollar’s implied strength due to the Fed’s tightening may soon decline based on European Central Bank President Christine Lagarde saying that the bloc will take a “gradual” approach to rate hikes in recent weeks. Markets in the continent are pricing in an ECB hike as soon as July. 

Any rate hike for the euro would harm UUP’s returns, as the fund overweights the euro in its basket of currencies relative to the dollar. 

“While the dollar’s run has been impressive, we’re probably getting closer to the end of a significant bull run than we are to the beginning,” Vecchio said. 

The dollar’s strength is also tied heavily to domestic economic conditions. If there are any signs that the U.S. economy is slowing, it may force the Fed to use smaller rate hikes. Such a move would reduce the dollar’s relative strength against other currencies based on anticipated spreads in central bank target rates. 

 
Contact Dan Mika at [email protected], and follow him on Twitter 

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