Market Overview

The U.S. Dollar: Jump Aboard or Move Aside? (UUP, UDN)


Currencies are very complex entities and are affected by a wide array of events and decisions. Despite the volatility, this asset class has been making significant headway into investor portfolios over the past six years, as currency ETF's first debuted in the markets in 2005. Before that, currency representation was virtually non-existent in the average American's investment strategies. Today, currency ETF's have assets totaling over $6 billion dollars. How times have changed.

So now with the U.S. dollar sitting at its one year low versus the Euro, investors are beginning to wonder whether or not they should start to accumulate the currency or get out of the way of another potential slide. There are multiple factors to consider when making this decision. For example, the U.S. dollar has only been this weak versus the Euro on three other occasions in the past twenty years; briefly in 1992, for most of 2008, and briefly in late 2009. Each time, the dollar quickly strengthened as the Euro got sold off, providing dollar investors with excellent gains in the process.

So here we sit, with oil at $110, silver and gold at all time highs, food prices soaring, and a U.S. monetary policy that makes Lehman Brothers look prudent. The Eurozone, which has had its own economic disasters to deal with over the past few years, recently raised interest rates to 1.25%. European Central Bank (ECB) president Jean-Claude Trichet cited accelerating inflation as the reason for the raise. The Euro, as a result, has been crushing the dollar and has sent commodity prices through the roof.

The Board of Governors of the Federal Reserve and the Federal Open Market Committee (FOMC) dictate U.S. interest rate policy and are set to release their decisions on April 27th. The benchmark interest rate in the United States has been at historically low levels (0.0-0.25 percent) since 2008, as the government has scrambled to make cash readily available to unclog the credit markets and to spur business spending and growth.

The decision to keep rates so low for so long has led to some substantial negative consequences, however. Commodity prices have soared, and are now pinching consumers. In the United States, where consumer spending accounts for nearly 70% of the economy, skyrocketing fuel and food costs are serious problems for the overall economy, as Americans tend to cut back on discretionary spending as a result.

The Fed needed to cut rates to unfreeze the credit markets during the financial crisis, but an abundance of cash in the market for prolonged periods is unwise for precisely the reasons stated above. How easily we forget that it was an overabundance of cash in the mortgage market that led to rapid inflation in housing prices, and, thus, the resulting crash and economic fallout. We are quickly reaching that tipping point again, only this time in the commodities market.

It seems unavoidable that the Fed will have to raise interest rates to combat this problem; the sooner the better. So, with interest rate hikes on the horizon seeming like a foregone conclusion, picking up the U.S. dollar at these historically low levels does not seem like a bad idea. Conversely, if you do not trust American policymakers to govern properly and expect the dollar to plunge even further to historical lows, there are ways to play that too. As of late, the dollar bears have been correct.

If you do not deal in futures, there are two ETFs that are very easy to use. The PowerShares DB US Dollar Index Bullish (NYSE: UUP), which is near its all time low, tracks performance of the U.S. dollar versus major world currencies (Euro, Yen, British Pound, Canadian Dollar, etc.). When the dollar strengthens, the fund goes up and vice-versa. On the other hand, there is the PowerShares DB US Dollar Index Bearish (NYSE: UDN) which tracks the same thing as its bullish counterpart; only when the dollar weakens, the fund rises.

Posted-In: Long Ideas Short Ideas Technicals Commodities Currency ETFs Politics Forex Economics Best of Benzinga


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