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U.S. Dollar to Strengthen? ETFs to Gain/Lose

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Despite a dovish Fed, the greenback has been steady in recent trading, with 2.6% year-to-date gain in Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) . The reason for this rally is the U.S. economy’s improved position amid vaccine distribution.

The dollar index rose against a basket of most major currencies lately, beating a two-week high despite falling yields on U.S. Treasuries as the Federal Reserve Chair Jerome Powell told Congress inflationary pressure will not be uncontrollable.

Notably, a third wave of the COVID-19 pandemic has already hit Europe. Germany is prolonging its lockdown and advising citizens to stay indoors during the Easter holidays. India has also been witnessing a surge in COVID-19 cases.

It appears to be a win-win situation for the greenback as the global health crisis has not dissipated yet. This fact provides support to the safe-haven trades. On the other hand, vaccination might reverse the economic slowdown in the United States and bring the economy back onto a faster growth path, which will boost the country’s currency.

Given the above-mentioned facts, the bullish trend in the greenback is likely to continue, at least in the near term.

ETFs to Buy

So, investors looking to play the strengthening U.S. dollar could consider the below-mentioned ETFs:

U.S. Dollar

The dollar strength can sure be played with UUP and WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU - Free Report) .

Small Caps

Since small caps are closely tied to the U.S. economy and do not get affected by a rising dollar due to their limited foreign exposure, iShares Russell 2000 ETF (IWM - Free Report) could be a good pick. Small-cap investing is more prudent at this time given a dovish Fed and massive stimulus rollout under the Biden presidency.

Dollar-Denominated Bond ETFs

Investors seeking EM exposure amid a strong dollar can consider dollar-denominated EM bond ETFs. These funds invest in sovereign debt from a variety of emerging nations via U.S. dollar-denominated securities. Notably, the debt route is less risky than equities. Moreover, most emerging markets have low debt levels compared to developed countries. iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB - Free Report) is one such ETF. The fund yields 4.00% annually.

ETFs to Sell

Inverse Dollar Fund

Needless to say, if the dollar is rising, a short position on the currency would result in negative returns. Invesco DB US Dollar Index Bearish Fund (UDN - Free Report)  should thus be avoided.

Commodities

The upsurge in the dollar is bad for raw materials and commodities as these are priced in the U.S. dollar. Furthermore, prolonged strength in the U.S. dollar might constrict growth picture, which in turn weigh on commodities’ prices. Invesco DB Commodity Index Tracking Fund (DBC - Free Report) can thus retreat ahead.

Large-Caps

Since large-cap stocks have greater foreign exposure, the strengthening dollar is 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. It is expected that the opposite will happen if the greenback surges. SPDR S&P 500 ETF Trust (SPY - Free Report) should thus be closely watched.

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