ETF Trends
ETF Trends

The PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP), the U.S. Dollar Index tracking ETF, is up more than 9% this year, a surge that is stinging an array of asset classes including emerging markets debt.

In a report released Sunday, the Bank of International Settlements notes that emerging markets companies have, in recent years, been prolific issuers of dollar-denominated debt. That worked when the Federal Reserve was depressing the greenback via quantitative easing and emerging currencies were rising. [EM Currency Rally Helps These ETFs]

However, QE is over and with many professional investors betting the Fed will raise interest rates next year, the dollar continues gaining steam. BIS notes the strong dollar will impair the ability of emerging markets issuers to repay dollar-denominated debt as their local currencies flounder.

Some ETFs are already pricing that dour scenario in. As UUP has risen 0.8% over the past month, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) has tumbled 2.7%. The $4.8 billion EMB is not an explicit corporate bond ETF, but some of its largest country weights are home to some of the deepest concentrations of state-owned enterprises in the developing world. [Ditching State-Owned Firms in an ETF]

“One of the key concerns highlighted from the BIS in their latest report is the speed and degree at which Emerging Market corporations have increased their US Dollar based funding,” said Rareview Macro founder Neil Azous in a research note out today.

Another way of looking at EMB is that not only is the ETF vulnerable to a strong dollar because emerging issuers could face debt-servicing issues, but also because some of the ETF’s largest country weights are major oil producers. For example, Mexico, Brazil, Russia and Colombia combine for nearly 20% of EMB’s weight. Among the major non-OPEC producers, none are more dependent on oil as a government revenue generator than Russia and Mexico. [Oil Hampers Frontier ETFs]

“While we hold the view that charts show you possibilities, and are not predictions, and we are not sure if these two technicals are the best metrics when analyzing emerging market debt charts, the fact is that a death-cross where the 50-day moves down and through the 200-day moving average is going to be confirmed this week statistically and that coincides with a break of a multi-year trend line with multiple touch points,” said Azous.

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