On rising speculation that the Federal Reserve is nearing its first interest rate hike of 2016, the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) is higher by nearly 2% over the past month.
UUP, 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, has been vexing investors for most of this year, but the widely followed currency could finally be poised to deliver a lengthy bull run if the Fed cooperates.
Not surprisingly, other currency ETFs are being crimped by UUP’s resurgence. The dollar and UUP have been weakening this year after the Federal Reserve signaled it would take a gradual approach toward interest rate normalization, dashing bets that a tighter monetary policy would support the greenback.
SEE MORE: ETFs That Welcome a Fed Rate Hike
The CurrencyShares Japanese Yen Trust (NYSEArca: FXY), which until recently had been one of the best-performing developed market currency ETFs, is off 1.6% over the past month. The dollar’s strength could also pressure the carry trade.
“As bond yields in advanced economies grind higher, this undermines the attractiveness of foreign exchange carry trades—ones in which the expected returns of a position are driven more by interest rate differentials on shorter-dated sovereign debt than by the change in one currency’s spot value relative to another. Typically, these carry trades involve a long position in an emerging market currency while borrowing in an advanced economy’s currency to fund the position,” reports Luke Kawa for Bloomberg.
A rising dollar also makes already hot U.S. government debt more attractive to investors, particularly those outside the U.S.
More international investors have piled in to the relatively attractive yields in U.S. government debt as foreign central bank policies have pushed international government yields to near zero or negative in some cases like Japan.
Related: Are Dollar ETFs Ready to Rally?
It might not take much for investors to ditch high-yield currencies, such as emerging markets fare, if the dollar continues its recent run.
“As the lower-for-longer environment has become increasingly entrenched in the mindset of market participants, it would take only a moderate selloff in sovereign debt among advanced economies to cause investors to shun higher-yielding currencies,” according to Bloomberg.
For more information on the greenback, visit our U.S. dollar category.