Market Overview

The Post-Fed Case For Dollar ETFs

The Post-Fed Case For Dollar ETFs

The Federal Reserve ended a nearly decade-long streak of not raising interest rates by boosting borrowing costs by 25 basis points. The U.S. central bank also indicated several more rate hikes await in 2016, the pace of that tightening is likely to measured and shallow.

Exchange traded funds tracking the U.S. dollar offered tepid reactions following the Fed news. For example, the PowerShares DB U.S. Dollar Index Bullish Fund (NYSE: UUP), the U.S. Dollar Index tracking ETF, closed higher by just a penny. UUP measures dollar action against euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

Dollar ETFs look better today as UUP and the rival WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSE: USDU) were each higher by nearly 1 percent at this writing. One day does not make a trend, but Thursday's showings for the marquee dollar ETFs could be a harbinger of things to come as market participants refresh bullish expectations for the greenback.

What is pivotal to the dollar's near- to medium-term fortunes is market participants reconciling the fact that the Fed is unlikely to surprise with unexpected tightening next year. For the moment, it is widely believed there could be up to four interest rate increases next year with the first likely arriving in March.

Related Link: El-Erian: Rate Hike Part Of 'Loosest Tightening' In Modern History

"For example, in 2004 the US interest rate market priced in a shorter, and steeper tightening path –where the Fed would tighten quicker, and in larger magnitude than what actually occurred. This is because the market has a memory. Because it experienced a steeper path of interest rate increases in the previous tightening cycles of 1994 and 1998, that was how the market approached the tightening cycle in 2004. However, the tightening cycle it experienced was flatter with a measured pace of 25 bps over the 17 subsequent meetings," said Rareview Macro founder Neil Azous in a note out Thursday.

Over the past 90 days, UUP and USDU are higher by an average of 3.2 percent. UUP would be done a good turn by additional monetary easing in developed markets, namely the Eurozone and Japan, though USDU features significant weights against the yen and euro as well.

Depending on one's point of view, the risk or reward with the actively managed USDU is that ETF's short emerging markets exposure. Emerging markets currencies, broadly speaking, have been nothing short of dreadful performers this year. However, that does not mean the same song will be played again next year.

"At the current moment, we are witnessing what by historical standards is a very divergent monetary policy setting, where literally ALL other major central banks are easing policy at the same time the US Fed is tightening. Moreover, in terms of hard currency reserves, the Fed will be withdrawing these reserves at the same time through quantitative tightening (QT) while other central banks will be creating new ones through quantitative easing (QE)," said Azous.

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