Currency ETF Plays on Euro
The dollar is gaining further against the euro Friday as the Fed’s plan to raise the discount rate in America has pushed up the value of the U.S. currency relative to the European Union’s.
This movement will add to the popularity of currency trading, which has taken center stage as a Greek tragedy plays out in Europe. While there’s no perfect ETF to play this move, there are two plays for investors here, one leveraged and one diluted.
ProShares UltraShort Euro(EUO) offers two times the daily move in the U.S. dollar versus the euro.
Volume has increased markedly since December, when the U.S. dollar enjoyed a brief rally versus most major currencies. Volume growth accelerated into January and February as the euro tumbled. Where EUO traded 50,000 to 100,000 shares per day in the autumn, it now trades 500,000 to 1 million or more shares per day.
Although it is a leveraged ETF, due to the lower volatility of daily currency moves, the tracking error has not been as large of a problem for EUO. Investors still need to time any trades correctly, but EUO is the most direct way to bet on a falling euro.
Another option is the PowerShares DB U.S. Dollar Index Bullish Fund(UUP), though UUP isn’t a direct a bet on the euro.
UUP tracks an index that is long the U.S. dollar against a basket of currencies containing the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc. The index weighs its exposure to these currencies at 57.6%, 13.6%, 11.9%, 9.1%, 4.2%, and 3.6%, respectively.
Like EUO, UUP has seen volume explode as investors turn to currencies, recently hitting a high of 17 million shares on Feb. 5, well above the sub-one-million share days for much of 2009.
While volume shows that investors are interested in trading currencies, asset flows suggest they haven’t been as bullish on the U.S. dollar, or at least the U.S. dollar ETF.
Last autumn, creation of UUP had to be halted twice due to capital inflows from dollar bulls. Once the dollar rally ended in December, though, funds began to exit, and assets under management have fallen from $3.2 billion at the end of 2009 to just $2.1 billion as of today.
This shows that investors are not bullish on the dollar as much as they are bearish on the euro, and 2010 performance bears this out. UUP gained 2.5% this year through Feb. 18, compared to a 4.9% loss in CurrencyShares Euro(FXE).
One factor holding back UUP has been the strength in the Japanese yen. Year to date, CurrencyShares Japanese Yen(FXY) has gained 1.9%.
Although there is not an ETF that goes long the dollar and short the euro without leverage, investors have two liquid options in UUP and EUO. Investors who expect a broadly stronger U.S. dollar, or who do not want to trade heavily, should stick with UUP over EUO. Those who want a focused play on a weaker euro should go with EUO.
For investors interested in emerging market currency ETFs tracking currencies such as the Chinese yuan or Indian rupee, see my previous article discussing the WisdomTree lineup .
