The CurrencyShares Euro Currency Trust (NYSEArca: FXE) started 2016 in surprisingly strong fashion, but with the year drawing to a close, FXE is in position to be one of this year’s worst-performing currency exchange traded funds.
While the ECB’s efforts to weaken the euro this year have not delivered on par with investors’ expectations, some market observers still believe the currency is heading for more downside. That does not mean the euro does not face more near-term downside, a scenario that could worsen for the common currency if the dollar rises in anticipation of higher interest rates in the U.S. After raising interest rates earlier this month, the Federal Reserve is expected to raise rates three times in 2017.
If the Fed hikes rates, the exchange value of the U.S. dollar will strengthen, or foreign currencies will depreciate relative to the greenback. Consequently, a non-hedged international investment will experience lower U.S. dollar-denominated returns.
Regarding the euro’s retrenchment, “the pace of the decline accelerated in 2014 as the dollar index exploded higher. And now, with the recent breakdown sparked by the ECB’s bond-buying news, it looks as if the euro is headed for parity with the dollar, meaning one euro equals one dollar in value. The last time this happened was in 2002,” reports Michael Kahn for Barron’s.
Of course, the slumping euro benefits ETFs such as the WisdomTree Europe Hedged Equity Fund (NYSEArca: HEDJ) and the iShares MSCI EMU ETF (NYSEArca: EZU), which is not currency hedged.
The European Central Bank (ECB) has been an issue for investors this year, but the ECB recently noted it will not taper its quantitative easing program, at least not in the near-term. Market observers argued that the ECB could even extend its bond purchasing program to further support inflation. The ECB has already spent over a trillion euros buying government bonds, cut its benchmark rate to zero and adopted a negative deposit rate.
The Deutsche X-trackers MSCI EMU Hedged Equity ETF (NYSEArca: DBEZ), iShares Currency Hedged MSCI EMU ETF (NYSEArca: HEZU) and the aforemetioned HEDJ target Eurozone countries but try to diminish the negative effects of a depreciating EUR – a weakening foreign currency would normally reduce returns on overseas securities when converted back into a stronger U.S. dollar.
“As for European stocks, the upside breakout this month is stark. Using the Stoxx 600 pan-Europe index, it is easy to spot the move out from the trading range that held it in check for most of this year,” according to Barron’s.
For more information on hedged options, visit our currency hedged ETFs category.