Since the beginning of 2017, the dollar has been in an almost constant decline.
In fact, the PowerShares DB ETF Bullish US Dollar (NYSE: UUP) has fallen more than 12% from its 2017 highs, despite a 2% increase.
UUP is an exchange-traded fund that measures the dollar against six other currencies. When the dollar strengthens relative to the others, the price of the UPU goes up.
In general, the dollar is considered a safe haven, a place for investors to put their money in times of market uncertainty. And since we’ve seen a market go straight up over a 15-month period, there was less demand for security assets like the dollar.
But that can only last so long. Right now, there is fear of inflation in the markets due to increased employment and wages.
When the economy is strong, inflation generally follows. That’s because when people make more money, they spend more. And when more money is spent, there is more in circulation, and the excess supply makes every dollar less valuable.
However, inflation fears are likely overblown due to the fact that we have not seen such a strong economy since before the financial crisis.
When inflation gets too high, it increases production costs and business slows down. But right now, inflation is stable at around 2%.
That may sound high, as it was around 0% for all of 2015 and part of 2016, but in the big picture, it’s normal. In fact, it is considered healthy.
For reference, inflation had exceeded 4% in 2005 and 2006, just when the economy was showing signs of slowing down.
Many wonder how to profit from this analysis.
Demand for the dollar
The dollar could easily strengthen from here as well.
Right now, a large part of the world economy has extremely low interest rates. Much of Europe, for example, is below 1% and they do not plan to aggressively raise rates anytime soon.
The United States, however, has a rate of 1.5%. This is not high, but we could easily see it surpass 2% this year if the economy remains healthy.
That would also raise the government bond rate, which is 2.86% right now. As the rate increases, international investors will start buying more US bonds, increasing demand for the dollar and raising its value.
How to benefit
Although the only way to invest directly in the strength of the dollar is through the UUP, there are other ways with a greater potential for return.
One is to buy call options on the UUP fund, but that is much riskier as you could lose your entire investment.
Another way would be to buy an ETF leveraged against a different currency.
For example, him VelocityShares Daily 4X Long USD vs. EUR ETF (NYSE: DEUR)returns four times the percentage that the dollar appreciates against the euro.
There are also similar funds that produce the return of the dollar against other currencies, such as the pound. (New York Stock Exchange: DGBP), the yen (NYSE: DJPY) and the australian dollar (New York Stock Exchange: DAUD).