As international central banks enact loose monetary policies, foreign investors have turned to U.S. government debt for higher yields, supporting gains in the U.S. dollar and currency-related exchange traded funds.
For instance, the U.S. two-year Treasury note currently yields about 0.83% while the Germany Bund 2-year yield is minus 0.32%.
The interest rate differential in favor of the U.S. reflects the diverging outlook on central bank monetary policies, with the Federal Reserve planning to raise rates for the first time in almost a decade and the European Central Bank expected to announce further easing measures, the Financial Times reports.
Yields on two-year U.S. Treasuries have been inching higher as the futures markets price in a 56% chance the Fed will hike rates from near-zero levels next month.
The higher yields on U.S. government debt, compared to German bunds, has attracted more European investment interest. Consequently, as Europeans invest in U.S. dollar-denominated assets, the investors have been selling euros for U.S. dollars. Since mid-October, the euro has slipped from $1.15 to below $1.09 as the spread between Treasuries and Bunds widened.
“There is no point in ignoring reality, it has become more obvious than ever that the monetary policies of Fed and ECB are drifting apart in opposite directions,” analysts at Commerzbank in a note. “The dollar is the beneficiary and is increasingly appreciating. Anyone still hesitating would be well advised to jump on the dollar bandwagon as soon as possible. Otherwise they may miss the opportunity altogether.”
Currency traders can track a strengthening U.S. dollar with the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP), which tracks the price movement of the U.S. dollar against a basket of currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. Additionally, the actively managed WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSEArca: USDU) tracks the USD against a broader basket of developed and emerging market currencies. Specifically, UUP includes a 57.6% tilt toward the euro currency and USDU has a smaller 30.5% weight in the euro.
On the other hand, aggressive currency traders can also target further weakness in euro through inverse ETF options. For instance, the ProShares Short Euro (NYSEArca: EUFX) is designed to provide 100% of the inverse, or opposite, return of the U.S. dollar price of the euro, on a daily basis and the ProShares UltraShort Euro (NYSEArca: EUO) provides 200% of the inverse return of the U.S. dollar price of the euro on a daily basis. Additionally, the Market Vectors Double Short Euro ETN (NYSEArca: DRR) tracks the Double Short Euro Index, which also provides a -200% exposure to the euro.
Currency traders will be watching for Friday’s October employment figures. Fed Chair Janet Yellen has stated that the central bank’s monetary policy relies employment strength and has already hinted at hiking interest rates as a “live possibility” at the December meeting.
For more information on the USD, visit our U.S. dollar category.
Max Chen contributed to this article.