U.S. dollar and currency-related exchange traded funds have turned around this year and could keep their momentum going as shifting supply and demand dynamics will continue to support the greenback.
The PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) increased 9.9% year-to-date. [Global Currency War Leaves U.S. Dollar ETFs On Top]
Meanwhile, the U.S. Dollar Index (DXY) is up 10.7% year-to-date.
“The strong U.S. dollar may have a lot further to run,” according to BlackRock analysts. “The law of supply and demand is at work here.”
Specifically, the analysts point to the diminishing pool of U.S. dollars. The U.S. current account deficit is shrinking – we are importing less, so we are exchanging less USD for foreign currencies, due to the lower need for oil imports. Additionally, the Federal Reserve ended its quantitative easing program, which cut the supply of dollars by $750 billion per year.
On the demand side, the U.S. dollar is becoming more attractive. With the Fed expected to hike rates while others like the Bank of Japan and the European Central Bank are adding QE, the diverging monetary policies will likely promote further demand for USD-denominated assets.
“The prospect of U.S. rate hikes and a shrinking trade deficit support a stronger dollar—but we brace ourselves for temporary reversals,” according to BlackRock. “We see the U.S. Federal reserve (Fed) ending its rate rises at a lower level than in recent decades.”
Moreover, the analysts argue that the global hunger for yield should cap spikes in 10-year Treasury yields. For instance, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which has a 7.76 year duration, comes with a 1.98% 30-day SEC yield while the yields on benchmark 10-year Treasuries are at 2.22%. In comparison, 10-year Japanese Government Bond yields are at 0.41% and 10-year German bund yields are at 0.68%. [Institutional Use of ETFs Continues Rising, Says BlackRock]
U.S. Treasuries remain an attractive for their yields and for their relative safety. Consequently, more overseas investors may turn to U.S. Treasuries, which will further support U.S. dollar demand, for the higher yields. [Overseas Capital Flight Could Maintain Dollar ETF Strength]
For more information on the greenback, visit our U.S. dollar category.
Max Chen contributed to this article.