With uncertainty continuing to plague much of developed Europe, growth slowing across China, and a whole host of other global macroeconomic problems beginning to surface, the hated U.S. dollar may be just what investors are looking for. Worries about the long-term prospects of the U.S. economy and its debt issues have driven the dollar downwards against the whole host of world currencies. However, as the rest of the world sees their uncertainties rise, the safe-haven status of the U.S. dollar is being reaffirmed and is acting like the reserve currency it once was. The near-term catalysts for a higher dollar are certainly there, and investors may want to position themselves accordingly.
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A Bullish Set-Up
Ultra-low interest rates, persistently high budget deficits and underfunded entitlement programs are some of the key reasons why the U.S. dollar has continued to fall over the decade. More recently, the Federal Reserve's quantitative easing programs and loose monetary policy was the latest nail in the currency's coffin. Expectations are that these programs (i.e. money printing) would generate higher-than-normal inflation over the longer term and then dilute the value of the currency. However, as the economic problems facing the globe have begun to intensify over the last few months, the greenback has rallied. Measuring the U.S. dollar against a basket of six major currencies, the Intercontinental Exchange's (NYSE:ICE) Dollar Index is currently sitting at $139. That's a stone's throw away from its 52-week high. More importantly, the index has been steadily rising since last November.
While in the long term the U.S. dollar may be toast, in the short to medium term, there is plenty to be bullish about. European Central Bank chief, Mario Draghi recently unveiled his second round of Long-Term Refinancing Operation (LTRO) programs, costing more than 530 billion euros. Likewise, a poor economic performance by Japan has many analysts speculating whether the Bank of Japan will need to undergo further easing and stimulus efforts. However, our own Ben Bernanke remains silent about the need for any further stimulus plans. The Fed chairman, in a recent testimony, said that the positives about the U.S. are outweighing the negatives, but didn't offer any sign that the economy needed an additional monetary boost. Overall, this lack of money printing can ultimately benefit and strengthen the dollar versus other currencies.
Finally, there could be another bullish sign for the dollar: rising energy production. The Financial Times reports that America's current-account deficit sits at 3% and "has been a long-standing drag on the dollar." The culprit has been America's addiction and imports of energy. The shale boom has spurred record production across the country and oil imports have already declined to 61% of total consumption. That's down from 65% in 2007. Analysts at UBS (NYSE:UBS) estimate that over the next few years, the current account will decline too much lower levels or possibly reach a surplus.
Playing the Bullish Greenback
Given the strengthening economy and lack of new money printing, a variety of analysts have turned increasingly bullish on the dollar, with a few even calling for euro-dollar parity sooner-than-later. For investors, the dollar's strength certainly came be played in a portfolio. The easiest way is through the PowerShares DB US Dollar Index Bullish (NYSE:UUP). The fund tracks futures contracts written against the USDX, and replicates the performance of being long the U.S. dollar against the euro, yen, pound, loonie, Swedish krona and Swiss franc. Expenses for the fund are relatively expensive at 0.81% and the fund has been roughly flat since its inception in 2007.
The PowerShares ETF is heavily allocated to the euro-dollar pair. It could see some under-performance, since it has some exposure to strong currencies like the British pound. Investors may find that using a direct euro-dollar play to be better. The highly liquid CurrencyShares Euro Trust (NYSE:FXE) is easily short-able, while the ProShares UltraShort Euro (NYSE:EUO) adds leverage to the mix.
Finally, perhaps the best way to play the trend is to go shopping internationally. A strengthening dollar represents a great time to pick up foreign stocks on the cheap, especially those that will benefit from a weaker home currency. A weak euro will benefit Germany's high engineered industrial goods and the Netherlands' agricultural products. Similarly, a weak yen will benefit Japan's electronics, steel and chemical exports. The iShares MSCI Germany ETF (NYSE:EWG), iShares MSCI Netherlands (NYSE:EWN) and SPDR Russell/Nomura PRIME Japan (NYSE:JPP) are great ways to play these nations.
The Bottom Line
Despite the long-term downward trend of the U.S. dollar, the currency has been getting stronger over the last few months as economic uncertainty continues to persist. Given the lack of future stimulus measures by the Fed, analysts expect the dollar to continue rising for the medium term. For investors, playing that trend could be a great bet and the proceeding ETFs are a great way to do that. (For related reading, see Profiting From A Weak U.S. Dollar.)
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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.