Currency Hedged ETFs for Exploiting ECB Easing

Last week, former Federal Reserve Chairman Ben Bernanke said the European Central Bank would face challenges in implementing U.S.-style quantitative easing.

That does not mean Mario Draghi, Bernanke’s ECB counterpart, is not going to try. Earlier this year, the ECB reiterated its low interest rate while announcing it is backing as much as 1 trillion euros, or $1.36 trillion, in two initial tenders and a series of quarterly auctions under its targeted longer-term refinancing operations, or TLTROs.

Last week, the ECB said it will expand its balance sheet by 1 trillion euros as a means of jolting slack economic growth in the Eurozone while stoking inflation. A weak euro is, of course, a key component in determining the success of the ECB’s QE ambitions and the currency is cooperating.

Over the past 90 days, the CurrencyShares Euro Currency Trust (NYSEArca: FXE) is off 7%. That decline has helped keep the spotlight on currency hedged exchange traded funds, one of this year’s hottest ETF asset classes. [Big Days for Hedged Currency ETFs]

FXE is lower by nearly 2.1% over the past month, enough for the DeutscheX-trackers MSCI Germany Hedged Equity Fund (NYSEArca: DBGR) to rally 6.2% while the Deutsche X-Trackers MSCI Europe Hedged Equity ETF (NYSEArca: DBEU) has soared 5.2% over that time. Those ETFs may just be getting started.

“QE creates new money, which devalues currency: Balance sheet expansion of € 1 trillion has historically resulted in a 10% weakening of the euro relative to the currencies of the Eurozone’s major trading partners, which the ECB would love to see again,” said Deutsche Asset & Wealth Management head of ETF Strategy Dodd Kittsley in a new research paper. “Higher import costs raise prices, and increased profit from exports should trickle into consumers’ pockets and boost spending. Based on past elasticities, weakening the euro could push inflation in the Eurozone up to the 2% ECB target zone by 2017.”

Due to the export-driven nature of Germany’s economy, the Eurozone’s largest, DBGR makes for a predictable beneficiary in a weak euro environment. DBGR, which has doubled in size this year, offers significant leverage to Germany’s export story with a 19.6% weight to the consumer discretionary sector. [Different Ways to Germany With ETFs]

Among those discretionary holdings are auto giants BMW and Volkswagen.

“Furthermore, Draghi stated on Thursday that the council would need to see unexpected deterioration in economic data before taking further steps. We don’t expect the staff’s new forecasts in December to be strikingly different from today’s market consensus. Deutsche Bank’s analysts believe that public QE will occur in early 2015,” adds Kittsley.

Although Draghi has yet to commit to Fed-style bond buying, it is clear some market participants are anticipating such an announcement is just a matter of time.