By John Nyaradi
Since mid-July, the greenback has been on a steady climb, which continued through August and now into September, and may be headed higher. Fundamental factors supporting the dollar are moves by the European Central Bank and the U.S. Federal Reserve.
The European Central Bank Governing Council recently voted to lower the benchmark interest rate to 0.05% – officially hitting the "lower bound," from which there would be no further interest-rate reductions. After the meeting, ECB President Mario Draghi announced that the central bank would begin purchasing asset-backed securities and covered bonds. The dollar soared and the euro weakened in response to Mr. Draghi's moves.
On our side of the Atlantic, the Federal Reserve has continued to taper its quantitative-easing program and now talk is turning to when the first interest-rate hike might come. While previous speeches by FOMC members have suggested that the rate hikes will begin during the third quarter of 2015, the recent flow of better-than-expected economic data has generated chatter that the new target could be in spring 2015. This week's FOMC statement and press conference are pivotal, and any hint of higher interest rates sooner will add strength to the U.S. dollar.
The most popular ETF for trading the dollar has been the PowerShares Deutsche Bank U.S. Dollar Index Bullish Fund /zigman2/quotes/209727862/composite UUP -0.27% . A look at the chart for UUP will reveal that a bullish "flag" has been forming since Sept. 10, and many investors are taking this as a buy signal. The dollar-based ETF is also well above key moving averages like the 20-, 50- and 200-day, which adds to the bullish picture.
In addition to UUP, there are a number of other trades which investors can consider in anticipation of a strengthening dollar. The most popular ETF for taking short positions on the euro is the ProShares UltraShort Euro ETF /zigman2/quotes/206913068/composite EUO -0.69% . This ETF is designed to obtain investment results which are twice the inverse (minus two times) of the daily performance of the euro. Because it is leveraged, investors must keep in mind that their losses will be twice as significant as the decline of the euro against the dollar on any given trading day.
Experienced investors and traders can consider a short position on the CurrencyShares Euro ETF /zigman2/quotes/208198139/composite FXE +0.36% . While this strategy avoids the risks incurred from investing in a leveraged ETF, it's hard to find shares to borrow from one's broker in order to short-sell FXE which makes this a more expensive and difficult strategy to pursue.
Overall, actions by the European Central Bank and the Federal Reserve point to the likelihood of continued U.S. dollar strength and euro-dollar weakness. As a side note, a strengthening dollar will likely also generate significant moves in U.S. stocks and emerging markets if and when the Fed actually starts to raise interest rates.