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What Lies Ahead of Dollar? ETFs in Focus

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The U.S. dollar is off almost flat in the three-month time period, up about 11.8% so far this year but lost 3.4% last week. The inflation data for the month of October came in softer-than-expected. The annual inflation rate in the United States decelerated for fourth month to 7.7% in October, the lowest since January, and below forecasts of 8%.

This led to an expectation that the Fed will pare down its pace of rate hikes. Traders expect the Fed to raise its benchmark lending rate in December but by a smaller margin of half a percentage point. As a result, the U.S. treasury bond yields fell. The U.S. benchmark treasury yield started the week at 4.17%, hit a high of 4.22% and ended the week at 3.82%.

However, the U.S. dollar recorded gains again to start this week as Fed Governor Christopher Waller on Sunday said the Fed may consider slowing the pace of rate increases at its next meeting but that should not be considered as a “softening” of its battle against inflation, per a CNBC article. Waller said markets should now pay attention to the “endpoint” of rate increases, not the pace of each move, and the endpoint is likely “a ways off.”

Hence, it all depends on inflation caused by supply chain issues. More than 40% of corporate decision-makers see a crucial need to overhaul their supply chains in 2023, with inflation, higher interest rates and weaker global trade posing threat to corporate profits, a new survey showed, per Business Standard. If such efforts can control price increases by corporates, inflation should cool down and Fed will also turn dovish.

Against this backdrop, below we do not expect the greenback to gain much strength ahead. Investors may wait and see and consider the below-mentioned ETF strategies if the greenback falls.

ETFs to Buy

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: Gold

The decline in the U.S. dollar is good for raw materials and commodities as these are priced in the U.S. dollar. SPDR Gold Shares (GLD - Free Report) gained 5.6% last week due to a sudden dollar weakness.

Large Caps

Since large-cap stocks have greater foreign exposure, the strengthening dollar is negative for this capitalization. BofA Global Research once estimated that every 10% drop in the U.S. dollar translates into about a 3% boost to S&P earnings, as quoted on Reuters. SPDR S&P 500 ETF Trust (SPY - Free Report) should thus be closely watched.

ETFs to Sell

U.S. Dollar

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

Dollar-Denominated Bond ETFs

Investors seeking EM exposure amid a falling dollar should not 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 the developed countries. Invesco BulletShares 2024 USD Emerging Markets Debt ETF (BSDE - Free Report) is one such ETF. The fund yields 3.33% annually.

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