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Is the Rally in U.S. Dollar ETFs Short-Lived?

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The greenback has been on an ascent, with PowerShares DB US Dollar Index Bullish Fund (UUP - Free Report) returning about 3.1% in the last one month (as of May 22, 2018). Steady U.S. economic recovery, which has proved sturdier than other developed economies in recent times and a prospects of faster-than-expected Fed rate hikes this year boosted the greenback.

The first reading of the U.S. GDP for the first quarter of 2018 advanced at a 2.3% annual rate of growth, above market expectations of 2%. U.S. consumer spending has also gained momentum (read: Q1 GDP Growth Beats Estimates: ETFs to Buy).

On the other hand, the European Central Bank (ECB) hinted at moderation in economic growth and the need to keep the policy rate constant. The British economy also marked the weakest growth rate in Q1. The Japanese economy contracted 0.2% sequentially in Q1 against the markets’ expectation of no growth.

Will the Uptrend Continue?

Maybe the recent rally in the U.S. dollar is temporary. We’ll have to wait for a quarter to see whether the slowdown in other developed economies is momentary or fundamental. This will give us an idea about the long-term course of currencies.

Apart from this, a Wells Fargo strategist noted in March that there is pain ahead for dollar bulls. The strategist pointed to a more fundamental factor that over the last 50 years, the greenback has actually treaded lower. 

Heavier U.S. government borrowing could be one of the factors behind this. High U.S. debt load (as much as $19 trillion) can have an adverse impact on the value of its currency (read: Are Dollar ETFs Poised for More Losses in 2018?).

Brandywine Global Investment Management recently forecast the greenback to slide about 5% by the end of 2018. Dollar’s its recent rally resulted in rich valuations and “the twin-deficit issue ought to put some pressure on the dollar,” said senior vice president for portfolio management at the Legg Mason Inc.

The U.S. budget deficit ballooned to $600 billion in the first half of the fiscal year, the Treasury Department said last month, as quoted on Bloomberg. The recent tax cuts and fiscal reflation approved by Trump are expected to goad the deficit to $804 billion in fiscal 2018 and then exceed the $1 trillion-level by 2020.

Moreover, a range-bound U.S. Treasury yields might cap the dollar rally. According to Pacific Investment Management Co., U.S. 10-year Treasury yield will hover in a 3-3.5% range for the rest of the year.

ETFs in Focus

Dollar bulls can play WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU - Free Report) apart from UUP. USDU is up 3.2% in the past one month. However, investors who are cautious about the long-term prospects of the greenback should focus on PowerShares DB US Dollar Index Bearish Fund (UDN - Free Report) . The bear fund is down 3.1% in the past one month (as of May 22, 2018) (read: 5 ETFs to Profit From a Dollar Rebound).

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