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U.S. Dollar Rising: ETF Winners & Losers

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After a rough year, the U.S. dollar started gaining ground. Thougha super-dovish Fed first marred the demand for the dollar, hopes of fatter fiscal stimulus under the Biden presidency has added strength to the U.S. currency lately.

President Joe Biden plans to take his case for a $1.9-trillion stimulus plan directly to the U.S. public on his first official trip outside of Washington probably in order to persuade Congress in sealing the stimulus deal on his terms.

Notably, Republicans on Capitol Hill are not in full support of Democrats’ proposed relief package, which includes “$1,400 cheques for individuals, extra funding for unemployment benefits, an increase in child tax credits and aid to state and local governments.”

If the $1.9-trillion stimulus plan gets through, we are to see a surge in U.S. treasury yields thanks to rising inflationary expectations. St. Louis Fed President James Bullard told CNBC that U.S. financial conditions were “generally good,” and that inflation was likely to gain steam this year, as quoted on Reuters.

Meanwhile, the New York Federal Reserve’s Empire State manufacturing report offered an upbeat economic picture, with a rise in its “prices paid index” giving cues of faster inflation. This should boost the U.S. dollar. The greenback has touched a four-month high against the yen as U.S. bond yields jumped.

According to Yukio Ishizuki, senior strategist at Daiwa Securities,“the dollar’s downtrend is over. At the start of the year, speculators were betting on a fall in the dollar below 100 yen. They seem to have abandoned such a view now,” as quoted on Reuters. Against this backdrop, below we highlight a few ETF areas that could gain/lose in the near term.

Greenback – Invesco DB US Dollar Index Bullish Fund (UUP - Free Report)

The fund follows the Deutsche Bank Long USD Currency Portfolio Index - Excess Return, which is a rules-based index composed solely of long U.S. Dollar Index futures contracts that trade on the ICE futures exchange. The fund charges 76 bps in fees (read: The Best Currency ETF of 2020 Will Surprise You).

Small-Caps – iShares Russell 2000 ETF (IWM - Free Report)

Rising rates add strength to the U.S. dollar. This is going to favor small-cap stocks that are more domestically exposed. Since these companies do not have much exposure to international markets, a higher greenback does not bother their profitability.

Currency-Hedged Japan – iShares Currency Hedged MSCI Japan ETF (HEWJ - Free Report)

Japan’s Nikkei surged to a more than 30-year high on rising expectations for a revival “in corporate earnings and economic growth”. The index recaptured the psychologically important 30,000 level for the first time since August 1990. This is a great scenario to ride out the momentum with a currency-hedged focus as the dollar rising. 

Losers

Large-caps – SPDR S&P 500 ETF Trust (SPY - Free Report)

Since large-cap stocks have greater foreign exposure, the rising dollar is a negative for this capitalization. BofA Global Research estimates that every 10% drop in the U.S. dollar translates to about a 3% boost to S&P earnings, as quoted on Reuters. Hence, large caps tend to lose in an opposite scenario.

Commodities – Invesco DB Commodity Index Tracking Fund (DBC - Free Report)

The uptrend in the dollar is a headwind for commodity prices as these are priced in the U.S. dollar. Moreover, “periods of dollar weakness tend to coincide with greater growth” (per Jeroen Blokland, portfolio manager at asset manager Robeco), which in turn benefits commodities. With the dollar seeing an upsurge, growth can be a little constricted.

Emerging Markets – iShares MSCI Emerging Markets ETF (EEM - Free Report)

Emerging markets also tend to underperform in a rising dollar environment, making it tougher for countries that have borrowings in the dollar to service their debt. Plus, investors won’t find the high-yielding emerging markets’ ETFs like EEM lucrative as domestic securities start yielding better.

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