Is It Time To Close Long U.S. Dollar Positions?

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About: Invesco DB USD Bullish ETF (UUP), Includes: UDN, USDU
by: Sankalp Soni
Summary

The UUP ETF has been declining over the past week from its all-time high of $26.02.

Declining oil prices are likely to dampen inflation going forward, which could make the Fed less hawkish.

Recent comments from top two Fed officials indicate increased dovishness, which could push the UUP ETF lower.

The Invesco DB US Dollar Bullish (UUP) ETF, which tracks the performance of the US Dollar, is up by about 7.44% YTD, currently trading at around $25.71. The long US Dollar trade has been quite profitable for most of this year. However, it has come down by about 1.19% over the past week from its high of $26.02 reached on Nov. 2, 2018, as the markets are anticipating a more dovish Fed going forward.

Source: Yahoo Finance

Prospectus Review

The ETF seeks to establish long positions in the ICE U.S. Dollar Index futures contracts to track changes in the level of the Deutsche Bank Long USD Currency Portfolio Index. The fund has an expense ratio of 0.76%.

The holdings of the UUP are:

UUP Holdings

Percentage of portfolio

Futures Dollar Index Dec18

50.01%

United States Treasury Bills

13.04%

CLTL - Invesco Treasury Collateral ETF

7.29%

Risk Note: It is possible that the Fund's performance may not fully replicate the changes in the levels of the Index due to disruptions in the markets for the relevant Index Currencies, the DX Contracts, or due to other extraordinary circumstances. The Managing Owner may determine to invest in other futures contracts if at any time it is impractical or inefficient to gain full or partial exposure to the Index Currencies through the DX Contracts.

Inflation Report

On Nov. 14, 2018, inflation data for October was released, which showed that inflation increased by 2.5% YoY during the month. The number matched market expectations and was higher than the previous month’s rate of 2.3%. This inflation rate is above the Fed’s 2% target, which allows the Fed to be more hawkish. However, it is worth noting that the price of oil was higher during October than it is now, which supported inflation higher. Given the recent bearish sentiment in the oil market (due to a global economic slowdown), oil is not expected to be a boost to inflation in the near future.

Moreover, the October core inflation rate, which is the rate excluding food & energy prices, came in at 2.1%, and missed the 2.2% forecast, and is also lower than previous month’s rate of 2.2%. I believe that slower core inflation and weaker outlook for the oil price will encourage the Fed to be less hawkish, which would put pressure on the USD and halt the UUP ETF from rallying higher.

Fed acknowledges headwinds

Fed chairman Jerome Powell also acknowledged last week that the US economy could face some headwinds going forwards. These included slowing global growth/ demand and the lagging effect of past rate hikes on the US economy. The fact that the Fed chairman is highlighting these issues signals to me that the Fed may become more bearish as we approach the December meeting. This is certainly a change of tone from his statement made on Oct. 3 that rates were “far from neutral”.

As a result, while the Fed is still expected to hike rates in December, I believe Powell may bring up these issues again during the Fed press conference on Dec. 19, in order to assure the markets that the Fed is certainly taking potential headwinds into consideration. Therefore, any potential dovish Fed communication will definitely put pressure on the dollar, and hence I believe that anyone with a long position in the UUP ETF should consider selling out of the position and booking any profits made this year.

Fed Vice chairman Richard Clarida also expressed dovishness last week, stating, “global growth is cooling”. Moreover, he also stated that the fact that short-term borrowing rates are currently at neutral “makes sense”. This gives a strong indication that he feels that the Fed has hiked enough and that there is a strong possibility that the Fed may pause its rate hikes in 2019. Hence, given that the top two officials at the Fed are expressing caution over the economy and increased dovishness could certainly halt the rally in the USD, and therefore push the UUP ETF lower.

Bottom Line

While the Fed could remain on its path for raising interest rates in the near future, markets tend to price in future actions. If Fed is more bearish in the December press conference, the market could price in fewer rate hikes going forward. Keep in mind that Fed communication on monetary policy guidance is a key driver of the US Dollar. Hence given the increased likelihood of dovish guidance from the Fed in December, this may be a good time to book any profits on long UUP ETF positions. I certainly do not recommend opening any long positions in the UUP ETF at this point.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.