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How to Play King Dollar's Best Week Since 2016 With ETFs

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The greenback has been steady this year with about 4.4% gains and got a solid impetus for an extended rally from central bank meets this week. In fact, possibilities of four rate hikes in the United States this year, an uptick in GDP growth guidance by the Fed and the release of solid retail sales data for May led the king currency to log the best week since 2016.

The dollar fund Invesco DB US Dollar Bullish (UUP - Free Report) gained about 1.3% on Jun 14 and 1.4% in the last five days (as of Jun 14, 2018) (read: Dollar ETFs Bounce Back: Can the Rally Continue?)

Inside the Surge

Fed’s Guidance

As widely expected, the Fed effected the second-rate hike of the year in its June meeting. The Fed raised the benchmark interest rates by a modest 25 bps to 1.75-2.00%, confirming the U.S. economy’s growth momentum and the labor market’s well-being.

The guidance for this year, however, turns a bit hawkish with a big section of policymakers seeking two more hikes this year, totaling four hikes in 2018. This is against the Fed’s previous projections of total three rate increases for this year. The median estimate implied three hikes in 2019. Federal funds rate projections for 2018 were upped to 2.4% from 2.1% and to 3.1% from 2.9% for 2019.

Other Central Banks’ Dovish Rate Outlook

This week was chockablock with central banks’ meeting. While the Fed is considering a faster-than-expected rate hike path, the ECB has pledged not to hike within one year and the Bank of Japan (BoJ) too kept the rate steady and downgraded its outlook on inflation. Such dovishness in other central banks brightened the relative appeal of the greenback.

Uptick in U.S. GDP Growth Forecast

The Fed upgraded its forecast for 2018 real GDP growth from 2.7% in March to 2.8%. Unemployment was guided down to 3.6% from 3.8% for 2018, 3.5% from 3.6% for 2019 and 3.5% from 3.6% for 2020.

Upbeat U.S. Retail Sales

U.S. retail sales registered the largest gain in six months in May. Sales increased 0.8% sequentially last month, after an upwardly revised 0.4% growth in April, and handily beat market expectations of a 0.4% rise. Higher sales at gasoline stations and motor vehicle & parts dealers led to the beat as well as the strengthened the outlook of the U.S. economy. This simply favored the U.S. currency (read: Here's Why the Rally in Retail ETFs Will Continue in 2H).

Given the global economic fundamentals, the bullish trend in the greenback is expected to continue at least for the near term. So, investors looking for a play on the U.S. dollar could consider below-mentioned ETFs:

Dollar

Needless to say, a strengthening dollar can 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 thrashed by a rising dollar due to their lesser foreign exposure, iShares Russell 2000 ETF (IWM - Free Report) could be a good pick in this kind of a situation.

Inverse Emerging Markets 

Emerging markets (EM) were caught off-guard by a rising dollar. Higher rates in the United States along with a stronger dollar dulled the appeal of emerging markets around the globe, leading many to sell their shares. So, investors can go short on EMs by investing in ProShares Short MSCI Emerging Markets (EUM - Free Report) (read: Top and Flop EM ETFs as Taper Tantrum Completes 5 Years).

Currency-Hedged Japan

As the dollar gained and the yen fell on BoJ’s tepid outlook on inflation, currency-hedged Japan ETFs like WisdomTree Japan Hedged Equity ETF (DXJ - Free Report) should do well.

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