How To Play Currency ETFs In The Year Ahead

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January 12, 2014 10:42pm NYSE:CYB NYSE:FXB

dollar etfCurrency markets saw an eventful 2013 with the dollar spiking, emerging markets currencies sliding, the yen setting multi-year lows every now and then and the Euro gaining and losing

strength with every move by the central bank.

A big reason for this movement in the world currency market was the taper talk in the U.S. that came into the picture in May and the ilikely mpact of the taper on emerging market capital flows. Also, huge monetary stimulus in developed markets like Japan and the U.K. as well as the Eurozone regulated the fate of theer respective currencies.

Let’s see how things are shaping up as we approach the New Year.

Finally Taper Hits & the Dollar Gains

After months of speculation, the Fed has finally decided on a modest tapering (worth $10 billion per month) from January 2014. The Fed chairman, Ben Bernanke commented that the bond buying program will be curtailed in phases in 2014 if improvement in the labor market matches their expectations, and may finally end by late 2014 (read: Fed Tapers Bond Purchases: 3 ETFs in Focus on the News).
The greenback climbed the day immediately after this announcement (on December 18) and is expected to move higher in 2014 again a basket of varied currencies.  Not only the gradual withdrawal of the Fed’s monetary stimulus, but also the steady U.S. economic growth will likely spur the value of the greenback.

In fact, last year the PowerShares US Dollar Bullish Fund (UUP) moved sideways in a very tight range of $21.32–$22.98 per share. From a technical viewpoint, its short-term moving averages have presently outpaced the long-term ones. Also, its relative strength index of 55.99 suggests that the fund is way behind the overbought territory. UUP currently holds Zacks Rank #2 (Buy).

Volatile Ride of the Euro 

Meanwhile, Euro stumped investors and analysts by gaining strength against the dollar and reached to its 2-year high as of December 27 primarily after European Central Bank governing council member Jens Weidmann cautioned that keeping interest rates low may endanger political reforms.
Eurozone returned to growth in Q2 after a two-year acute debt crisis and inflation eventually picked up in the region. This has helped drive this single currency to some extent.

Moreover, some experts believe that the strength in euro emanates from some year-end factors which include liquidity crunch in the euro zone as European banks are repaying crisis loans to the European Central Bank which in turn raised short-term interest rates and the currency.

As a result, CurrencyShares Euro Trust (FXE) – designed to reflect the price of the Euro in USD – gained 1.21% over the last one-month period (as of December 27). However, investors should be extra cautious before adding long positions in the Euro as the euro zone recovery is still far from reaching the desired level and the region might need stimulus in the coming days putting a strain on Euro. On the contrary, USD will likely shoot up with each measured QE withdrawal thus marring the appeal of Euro next year. Notably, FXE currently has a Zacks Rank #5 (Strong Sell).

The Surge in the British Pound; Will it Continue? 

The British Pound Sterling has been awaiting a turnaround for the past few months and finally seems to have got a boost from stronger economic recovery in the U.K. which in turn spurred the speculation about the central bank’s less accommodative monetary policy ahead of the anticipated timing.

This has provided some relief to the struggling currency with the CurrencyShares British Pound Sterling Trust ETF (FXB) – designed to track the performance of the British Pound Sterling – adding 1.15% over the last one month. FXB is currently hovering near its 52-week high price with the pound jumping to the highest level in two years against the dollar. Citigroup currently considers Sterling as a global “safe haven” currency in 2014.

Here also we would like to highlight some concerns. Of late, the BOE has decided not to consider a rate hike until the unemployment rate falls to 7% from its current 7.6% indicating that the time to cheer for the British pound is yet to come. In any case, FXB has a Zacks Rank #5 (Strong Sell).

Slide in the Yen to Continue 

The most talked currency fact this year was a depreciating Japanese Yen. Thanks to the Bank of Japan (BOJ)’s targeted measure to end a long-stretched deflationary rut and trigger growth, Yen is now trading at its 5-year low level.

The Bank of Japan follows a policy to increase the country’s monetary base at an annual run of about 60–70 trillion yen. This injection of artificial liquidity – which will continue until the inflation target reaches 2% – devalues the Japanese Yen. Consequently, CurrencyShares Japanese Yen Trust (FXY) lost 2.89% over the last one month and 17% in the year. FXY currently carries a Zacks Rank #4 (Sell).

In fact, FXY hit a fresh 52-week low of $92.88 on December 27. With the Fed taper already decided on and the BOJ’s stimulus still in place, the Yen will likely lose more strength relative to the greenback in the coming days.

Emerging Market Currencies: the Real Loser

The going was extremely tough for emerging market currencies this year with the WisdomTree Emerging Currency Fund (CEW) shedding 5.45% this year. The firmness in dollar and a general risk of trade led to this malaise. The crisis became more acute with countries having large current account deficit – such as Indonesia and India. In fact, Indian Rupee was the second worst performing emerging markets’ currency in 2013, plunging more than 10% against the dollar.

Though the majority of the emerging markets have already priced in the initial taper shock and are not likely to see much volatility in the initial part of 2014, these currencies should witness a major setback in the latter half of the year as the Fed speeds up the QE pullback. Hence, its better to stave off emerging markets’ currency exposure in 2014 (read3 Currency ETFs Crushed in Emerging Market Rout).

If investors at all seek a touch of EM currency in their 2014 portfolio, Chinese Yuan could be an intriguing option for them. Market Vectors Chinese Renminbi/USD ETN (CNY) has added 3.1% in YTD frame braving the taper fear whileWisdomTree Dreyfus Chinese Yuan (CYB) fell only 0.43%.

Yuan became the second-most used currency in international trade after the U.S. dollar leaving behind the Euro and Yen. The rising use of the yuan, also known as renminbi led to a higher demand for the currency thus pushing up its price.  Both the above-said Yuan products presently carry a Zacks Rank #3 (Hold).

Bottom Line

In a nutshell, the greenback will rule the year 2014. Apart from the dollar, no other currency is promising outright appreciation relative to the USD. Only investors having long positions in Chinese Yuan, Canadian dollar and Euro can take a wait-and-see approach.

This article is brought to you courtesy of Eric Dutram.

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