McCall’s Call: What If The Dollar Strengthens?

Does the fate of the dollar hinge on the actions of the Federal Reserve and its monetary policy? Or will the greenback be more heavily influenced by outside factors such as the stability of the euro or the White House's hope to spur exports?

Matthew D. McCall

Since that time, the SPDR S'P 500 ETF (NYSEArca:SPY) is up 4.9
percent through the end of the quarter, including dividends. Many
investors may find it hard to fathom that stocks are up over the
last 13 months, but, until the third quarter, they were performing
quite well.

Such questions are suddenly on the front burner after Standard & Poor's put the creditworthiness of the U.S. on negative outlook last week.

The U.S. Dollar Index jumped 0.9 percent on the S&P news Monday, but a few days later the index was sitting at a three-year low. It's apparent that investors view the downgrade as a wake-up call regarding the U.S. budget deficit.

More specifically, it doesn't look likely that the U.S. government will truly address its budget problems in the near term, which means it's likely to print more money. That means more money will be in circulation and the currency is likely to keep falling.

That's one reason I wouldn't rush just yet to tweak investor portfolios in preparing for the day when the dollar catches a strong bid in currency markets.

But thinking about ETFs that will flourish as the dollar strengthens is wise because the day will come, and it's better to be ahead of the crowd than behind it.

No More Easy Money

Even if Federal Reserve Chairman Ben Bernanke keeps the era of "easy money" that has prevailed since the market crashed in 2008 in place for the next several months, he will still, without any doubt, wake up to the fact that the economy has been steadily improving and that inflation is rapidly becoming a major concern.

When that occurs, probably early next year, higher interest rates and a stronger dollar will almost surely follow.

As interest rates increase in the U.S., more money is likely to come into the country as investors take advantage of the higher rates of return on their money.

This influx of foreign money into the U.S., in turn, has an effect on exchange rates and would boost the dollar.

Dollar ETFs

Like I said above, I think it's a little too early to move into dollar ETFs designed to profit from a strengthening greenback.

However, investors must be prepared to make the move before the masses.

The single-best ETF to play a strengthening dollar is the PowerShares DB US Dollar Index Bullish ETF (NYSEArca:UUP). The ETF tracks the movement of the U.S. dollar versus a basket of foreign currencies. The fund, which has an annual expense ratio of 0.75 percent, is currently at a multimonth low. Tempting as it may be, now is not the time to begin bottom-feeding.

In the spirit of full disclosure, my firm currently has a position in UUP's bearish sibling, which tracks the inverse of the U.S. Dollar Index. The PowerShares DB US Dollar Index Bearish ETF (NYSEArca:UDN) also costs 0.75 percent a year.

The Wild Card

The U.S. government is the wild card in the scenario I laid out above; namely, the dollar is likely to remain weak for the remainder of the year before finding a bottom on the back of higher interest rates sometime early next year.

After all, President Obama said earlier this year that he wants to double U.S. exports by 2015. The only way this can come close to being achieved is if the dollar remains weak.

So, even though fundamentals point to a stronger dollar at some point early next year, you have to remember that when you're up against goals set by the strongest government in the world, you have to be careful.

Matthew D. McCall is editor of The ETF Bulletin andpresident of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.

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Copyright ® 2011 Index Publications LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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