The Strong Dollar Catalyst No One Is Talking About
There is a reason the WisdomTree Europe Hedged Equity Fund (NYSE: HEDJ) and the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (NYSE: DBEF) are the top two asset-gathering ETFs this year, having added more than $27.7 billion in new assets combined.
There is a reason why the PowerShares DB US Dollar Index Bullish Fund (NYSE: UUP) and the WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSE: USDU) are up an average of 3 percent, making the pair two of the best-performing currency ETFs. The reason is essentially the same. Earlier this year, traders bid the dollar higher in advance of the Federal Reserve raising interest rates, something the central bank obviously has yet to do.
As market participants have had to re-calibrate rate hike expectations, the aforementioned dollar ETFs have slumped, posting negative returns over the past 90 days. Likewise, currency hedged ETFs, at least for the moment, are no longer the toast of ETF Town. There was a point earlier this year when four of the top 10 asset-gathering ETFs were currency hedged funds. That number has subsequently been reduced to two: HEDJ and DBEF.
For dollar bulls and fans of currency hedged ETFs alike, there is potentially good news and it is perhaps the best variety: The kind that few are discussing. Better yet, those good tidings do not prompt investors to continue trying to find a crystal ball that reveals exactly when the Fed is going to raise rates.
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Remember all those Treasuries and mortgage-backed securities (MBS) the Fed bought to fuel its various iterations of quantitative easing? Those assets are coming due starting in 2016 and that could prompt some non-rate hike Fed tightening that spurs the dollar higher.
"In 2016, and in the following years, there will be about $500bn of assets maturing on the balance sheet per year between US Treasuries and Mortgage-Backed Securities (MBS), which is the equivalent of draining about half of the assets added to the balance sheet in 2013. This will be very US dollar positive. Effectively, it is the equivalent of the Fed going into the FX marketplace and making a block purchase of US dollars," said Rareview Macro founder Neil Azous in a note out Wednesday.
As Azous points out, over the past 90 days, the three best-performing major currencies against the dollar are the euro, yen and Swedish krona. That is not good for any of the aforementioned ETFs. Euro and yen strength are particularly punishing for HEDJ, USDU and UUP. Additionally, DBEF can be pinched by euro and krona strength.
The Market Vectors-Renminbi/USD ETN (NYSE: CNY) has not been a slouch either, despite the Peoples Bank of China's best efforts. CNY is up 1.5 percent over the past month. More good news for dollar and currency hedged ETFs: Those funds do not necessarily need the Fed to boost rates. Other central banks adding to already substantial QE efforts will do just fine.
"Add in the idea that the BoJ, ECB, and PBoC will have to ease further to weaken their currencies and remain competitive, and there is a floor for the US dollar. Outside of what is being priced into the fixed income market and the potential shift in the monetary policy dynamic, ultimately we are not far from it," said Azous.
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