Ever since the start of 2017, the dollar has been in an almost constant decline.
In fact, the PowerShares DB U.S. Dollar Bullish ETF (NYSE: UUP) has dropped over 12% from its 2017 highs, despite a 2% gain.
UUP is an exchange-traded fund that measures the dollar against six other currencies. When the dollar strengthens relative to the others, the price of UUP goes up.
Generally, the dollar is seen as a safe haven, somewhere for investors to put their money in times of market uncertainty. And since we have seen a market that went straight up over a 15-month period, there was less demand for safety assets like the dollar.
But that can only last so long. Right now, there is a fear of inflation in the markets due to higher employment and wages.
When the economy is strong, inflation usually follows. That’s because when people make more money, they spend more. And when more money is spent, there’s more in circulation, and the excess supply makes each dollar less valuable.
However, inflation fears are likely overblown due to the fact that we haven’t seen an economy this strong since before the financial crash.
When inflation gets too high, it sends production costs up and business slows. But right now, inflation remains steady around 2%.
That may seem high, as it was around 0% for all of 2015 and some of 2016, but in the big picture, it’s normal. In fact, it’s seen as healthy.
As a reference, inflation had gotten over 4% in 2005 and 2006, right as the economy showed signs of slowing.
Many are wondering how to profit from this analysis.
Demand for the Dollar
The dollar could easily get stronger from here as well.
Right now, a huge part of the world’s economy has extremely low interest rates. Much of Europe, for example, is under 1%, and they aren’t planning on raising rates aggressively anytime soon.
The United States, however, has a rate of 1.5%. This isn’t high, but we could easily see that go over 2% this year if the economy stays healthy.
That would also increase the rate of government bonds, which is 2.86% right now. As the rate get higher, international investors will begin to buy more U.S. bonds, which increases demand for the dollar and sends its value up.
How to Profit
Even though the only way to directly invest in the strength of the dollar is through UUP, there are other ways with higher return potential.
One is buying call options on the UUP fund, but that’s much riskier, as you could lose your whole investment.
Another way would be buying a leveraged ETF against a different currency.
For example, the VelocityShares Daily 4X Long USD vs. EUR ETF (NYSE: DEUR)returns four times the percentage that the dollar appreciates against the euro.
There are also similar funds that produce the return of the dollar against other currencies, like the pound (NYSE: DGBP), the yen (NYSE: DJPY) and the Australian dollar (NYSE: DAUD).
Ian Dyer is one of the top internal analysts for Banyan Hill Publishing. He graduated from Duquesne University with a degree in finance. He has passed the Level 1 and 2 CFA exams to become a Level 2 CFA, and will soon complete the final Level 3 exam. Becoming a Level 3 CFA demonstrates an analyst’s thorough command of economics, accounting, portfolio management, stock and bond valuation, and more. For the last few years, Ian has utilized these skills to analyze valuable investment recommendations for Banyan Hill’s 300,000 readers. Read more here.