Looking for exposure to the foreign exchange market? Currency exchange-traded funds (CETF) are one avenue worth considering.
CETFs act as vehicles for portfolio diversification, hedging and speculation into the largest and possibly most liquid financial market. According to the Bank for International Settlements, trillions of US dollars are traded daily on the forex market, primarily by institutions. On average, retail clients contribute around 5% of the total volume. As a trading center, London accounts for close to half of the total activity.
The value of a currency is typically driven by interest rates, economic developments, national and global politics. There are a wide range of funds covering different currencies as well as both long and short (inverse) position ETFs and double and triple long and short funds.
Here we'll take a closer look at one of the most important currency ETFs in the market:
Invesco DB US Dollar Index Bullish Fund
- Current Price: $24.90
- 52-Week Range: $24.64 - 28.90
- Expense Ratio: 0.77% per year, or $77 on a $10,000 investment
The Invesco DB US Dollar Index Bullish Fund (NYSE:UUP) enables investors to track the value of the greenback relative to a basket of six major world currencies, i.e., the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. They represent the currencies of some of the most significant US trading partners.
The fund has exposure to futures contracts in the US Dollar Index (USDX), possibly the world's most recognized currency index. The USDX is heavily exposed to the euro, as well as other European currencies. Since UUP goes long the US dollar and shorts the currencies of major US trading partners using USDX futures, when the euro rises, the fund goes down.
UUP is setting new lows right now. The fund's current downtrend accelerated in the second half of May. It is now around the levels seen in September 2018, where it may find support—at least for some time. However, if the decline continues, a fall toward the $23-level is likely.
If we go back to the timeframe after the 2008/09 crisis, UUP's performance at the time was also negative as the greenback suffered declines. Many analysts wonder if UUP's trajectory or underperformance will be similar during the COVID-19 pandemic.
The US dollar tends to have long periods of appreciation and depreciation. Because moves can become long and over-extended, it could be premature to speculate the downtrend will end soon.
Despite the recent slide, the USD remains the world’s preeminent currency and UUP will eventually reverse higher.
However, a number of factors will likely affect the timing and extent of the next potential move up. In part, it will depend on how fast the US economy will recover, especially vis-à-vis the major European economies. Short-term moves could also be dictated by news around the regulatory approval of a potential coronavirus vaccine, economic data releases and the upcoming US Presidential election.
For the rest of the year, economic data will likely continue to hinder the US dollar's safe haven status. A potential delay in announcing the winner of the Presidential election would also have an adverse effect on the value of the currency. For any up-move to become a long-term trend, UUP would need to go and stay over $26.
Bottom Line
In 2020, asset classes are witnessing the battle of the safe havens, leading to increased volatility in the financial markets. Those investors who would like to have exposure to foreign exchange moves may consider buying into CETFs. In the coming weeks, we will revisit the topic and discuss several other funds including: