The year-long rally in the U.S. dollar has slowed, but it’s far from over.
From July 2014 to March of this year, the U.S. Dollar Index (DXY) has soared by 25%. Since then, it has pulled back slightly. But the forces that drove the U.S dollar higher remain in place and will intensify in the months ahead.
That means investors can expect a stronger U.S. dollar against most foreign currencies, including the euro, the Japanese yen, the Australian dollar, and the Mexican peso.
It matters because the value of the U.S. dollar holds a pivotal spot in the world of investing.
“The U.S. dollar is the oxygen of the global economy. Everyone takes it for granted, but it determines the value of every financial instrument in the world – stocks, bonds, commodities, real estate, art, collectibles, you name it,” said Money Morning Global Credit Strategist Michael Lewitt.
Why a Strong U.S. Dollar Matters
Specifically, the strong U.S. dollar is the main reason that prices for commodities like oil, copper, and aluminum are down. Because commodities are priced in dollars, a more valuable dollar buys more of them for less money.
The rising U.S. dollar has also hurt the earnings of U.S. corporations with significant overseas businesses. The strong U.S. dollar makes U.S. exports more expensive.
Finally, the strong U.S. dollar has made life miserable for emerging markets. Governments and companies borrowed a lot of money denominated in dollars, Lewitt said. A stronger dollar makes those debts more expensive to repay.
So how can we be so sure the U.S. dollar will keep rising?
Simple, Lewitt said. While the U.S. Federal Reserve has spent the past year winding down its quantitative easing policy, other major central banks – particularly the European Central bank (ECB) and the Bank of Japan (BOJ) – have ramped up their monetary easing.
Such QE policies weaken currencies.
But the Fed is now going against this global tide. Regardless of whether it raises interest rates this week, it has signaled its intent to do so this year or early in 2016.
“Even if the Fed doesn’t move, the ECB and Bank of Japan are committed to further weakening their currencies. That means further dollar strength can be expected,” said Lewitt.
And that’s going to be tough on several currencies in particular…
The Euro, Yen, and Peso Have All Slipped Against the U.S. Dollar
Here’s what the U.S. dollar is doing against some key currencies:
- The U.S. Dollar-Euro Pair (USD-EUR): A year ago, the euro was worth $1.30; now it’s down to $1.12. The euro’s downward trend got a push from the ECB’s first QE program in January. Several big banks, including Barclays Plc. (NYSE ADR: BCS) and Bank of America Corp. (NYSE: BAC) have forecast the euro will drop to parity with the U.S. dollar by the end of the year and will fall below the $1 level in 2016.
- The U.S. Dollar-Yen Pair (USD-JPY): As recently as October 2012, $1 was worth 80 Japanese yen. Now $1 is worth more than 120 Japanese yen. That’s a 50% change in three years. The BOJ’s determination to further weaken the yen is expected to drop it to 130 against the U.S. dollar by the end of 2016 and 140 by the end of 2017.
- The U.S. Dollar-Yuan Pair (USD-CNY): The Chinese government shocked the world in August when it loosened some of its controls on the yuan, causing it to plunge 2.1% in a day. The Chinese yuan is down 2.6% against the dollar for the year. According to a CNNMoney survey of economists, the Chinese yuan will fall another 2.8% against the U.S. dollar by the end of 2015 and further still in 2016.
- The U.S. Dollar-Peso Pair (USD-MXN): The Mexican peso is down more than 21% against the U.S. dollar over the past 12 months. The Mexican peso has been slammed by the big drop in oil prices, forcing the Mexican central bank to sell U.S. dollars to try to prop up its currency. But here the worst is over. Forecasts call for the Mexican peso to stabilize then gain a little ground back from the U.S. dollar in 2016.
- The U.S. Dollar-Australian Dollar Pair (USD-AUD): The Australian dollar has been hit by that nation’s exposure to a slowing Chinese economy as well as the plunge in commodity prices. The Aussie dollar is down about 22% against the U.S. dollar over the past year. It’s currently at about $0.71 to USD $1. ANZ Research predicts the Aussie dollar will slip a bit further – possibly as low as $0.60 – before recovering back into the low $0.70 range next year.
What Investors Can Do About the Strong U.S. Dollar
“Investors can profit from the dollar rally by investing in dollars and selling short euros and yen,” Lewitt said.
He suggests three ETFs:
- Buy the ProShares DB US Dollar Bullish ETF (NYSE Arca: UUP), which closely tracks the exposures in the DXY. This ETF rises when the dollar rises.
- Buy the ProShares Short Euro ETF (NYSE Arca: EUFX). This ETF rises when the euro falls.
- Sell short the Guggenheim Currency Shares Japanese Yen Trust ETF (NYSE Arca: FXY). This short position will rise in value as the yen weakens.
- Buy the ProShares Short MSCI Emerging Markets ETF (NYSE Arca: EUM) to profit from continued weakness in emerging markets. This ETF rises when emerging markets stocks weaken.
Someday, of course, the U.S. dollar will collapse from the weight of the $18.4 trillion U.S. national debt and the more than $4 trillion the Fed added to its balance sheet through several bouts of QE.
But for now, it’s time to profit from a stronger U.S. dollar.