Trading Dollar Strength Through 2 Funds

You might have seen headlines every now and then that talk about how the US dollar is strengthening or currently strong or is losing ground or weak. For most people, the only time foreign exchange (F/X) rates come into play is when they are planning a vacation out of the country. For some investors, F/X trading is a game best played by scraping fractions of pennies on 9-figure bets throughout the trading day, which, for currency markets is 24/7. Finally, there are some investors like George Soros who take big macro bets like his famous call on the UK deciding to not give up GBP for the Euro. While it's always nice to save a couple of dollars on your vacation, wouldn't it be nicer to be able to take advantage of USD strength without having to find a 9-figure fortune, let alone put it at risk? Recent headlines have been talking about current dollar strength and some analysts are forecasting continued USD strength throughout 2022. So how can ETF investors trade these forecasts? Regular readers will know that one of the things I like about ETFs is that while they kicked off the industry as vehicles for basic exposure to broad market beta, the product's structure is well suited to hold both simple and complex strategies alike. Trading Dollar Strength F/X trading can involve complex strategies like triangular arbitrage, where traders try to take advantage of currency mispricing across three currency pairs. For example, simultaneously use dollars to buy GBP, use that GBP to buy Euro, and then use that Euro to end up with dollars again and if you've done the math correctly, you've made some risk-free money. Thirty years ago, institutions might have been able to find these trades. Today, these trades are about as plentiful as unicorns and I'm not talking about billion dollar startups, I'm talking about actual single horned magical horses. Especially for us mere mortals, trading USD strength can get complicated. Or you could take a look at the following ETFs that provide investors exposure to a strengthening USD trade. Launched in February 2007, the Invesco DB US Dollar Index Bullish Fund sports a 75 basis point expense ratio meaning that a shareholder with $1,000 invested over a calendar year would expect to pay fees of $7.50 over that period. This fund tracks the ICE US Dollar Index (USDX). The 50 basis point WisdomTree Bloomberg US Dollar Bullish Fund was launched December 2017 and tracks the Bloomberg Dollar Spot Index (BBDXY). Let's take a look at how each of these funds gets investors USD exposure and what historical results have been, at least since the launch of USDU. UUP As mentioned, this fund tracks the ICE US Dollar Index and gets its exposure to USD by shorting a basket of currency pair futures. It was developed by the Fed in 1973 in response to going off the gold standard. Currencies and allocations were trade weighted. The index currently tracks the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and the Swiss Franc. Interestingly, the only time weights in this index were changed was when the Euro launched, and the original currency basket was adjusted to accommodate the then new currency. Current weights are as follows: Euro 57.6%, Japanese Yen 13.6%, British Pound 11.9%, Canadian Dollar 9.1%, Swedish Krona 4.2%, and Swiss Franc 3.6%. USDU This fund tracks the Bloomberg Dollar Spot Index which looks like it was launched in 2016. The index uses a similar trade-weighted methodology to select and allocate among currencies but has a different makeup and also includes the Mexican Peso, Australian Dollar, Korean Won, Chinese Renminbi, and the Indian Rupee, but excludes the Swedish Krona. Renminbi exposure is capped at 3% and any currency representing less than 2% of trade is excluded and that allocation is added to the remaining currencies on a pro-rata basis. Current weights can be found here. Dollar Strength Is Dollar Strength, Right? As you can see from the below chart, UUP has outperformed USDU since USDU's launch in December of 2017. While I am not extremely well versed in global currency markets, I do know that the 2020 reaction to the Covid pandemic saw the dollar weaken significantly as global traded ground to a halt. As we continue to emerge from the past two years the dollar has regained much of that strength. Further, as the Fed embarks on its tightening regime and the US economy continues to chug along... investors will want those higher-yielding bonds, the Fed will be reducing the money supply by shrinking its balance sheet, and workers and companies alike will be demanding more dollars making the US Dollar attractive and a place to be, relatively speaking. Indeed, YTD to April 25, 2022, USDU is up 4.76% and UUP has gained 6.05% as compared to the SPDR S&P 500 ETF Trust's return of -9.78% on a cumulative basis. As for which fund to choose if you decide to allocate to USD, based on both recent and historical returns it looks like UUP might be worth taking a good look at. I'm thinking this may be a time when the old K.I.S.S. principle comes into play.

Trading Dollar Strength Through 2 Funds

I'm thinking this may be a time when the old K.I.S.S. principle comes into play.

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