UDN: Should You Buy This Bearish US Dollar ETF?

About: Invesco DB US Dollar Index Bearish ETF (UDN)
by: Sankalp Soni

The UDN ETF is down by about 9.29% from its 52-week high.

Randal Quarrel's statements imply a more data dependent Fed.

Employment conditions continue to weaken, which could encourage the Fed to become more dovish.

The Invesco DB US Dollar Bearish (UDN) ETF, which inversely tracks the USD against six major currencies, is down by about 9.29% from its 52-week high in February 2018. This is because ‘short’ bets on the USD have not been successful amid a hawkish Fed for the most part of this year. However, the Fed has recently been turning increasingly dovish amid slowing growth concerns, which could potentially pull the USD lower going forward, and allow the UDN ETF to rally higher. This article further examines into whether investors should buy into the ETF.

Source: Yahoo Finance

Prospectus Review:

The ETF inversely tracks the Deutsche Bank Short US Dollar Index Futures Index. The fund seeks to track the index by establishing short positions in DX Contracts. DX Contracts are linked to the six underlying currencies, or the index currencies, of the U.S. Dollar index (USDX®), or the USDX®. The index currencies are Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. The annual net expense ratio of the ETF is 0.76%.

Source: Invesco

Risk Note: Because the value of the USDX® could, in theory, rise infinitely, a short position in DX Contracts exposes the Fund to theoretically unlimited liability. The Fund’s losses could result in the total loss of your investment.

The distinctive reason I have chosen this particular ETF to short the USD is because it shorts the USD against various different currencies of developed countries, mitigating the risk of solely being exposed to just one currency to short the Dollar against, thereby offering more diversification.

Randal Quarles’s statements

Market participants recently have been focusing on the Fed aiming to hike interest rates until the ‘neutral’ rate is reached. The ‘neutral’ rate is considered the level where monetary policy is neither accommodative nor tightening. The market is currently assuming that the neutral rate is 3%. Though Randal Quarles, who is a voting member at the Federal Reserve, claimed that the concept of a ‘neutral’ rate is not very useful, because this rate could continue changing overtime. As economic conditions fluctuate, the rate that can be considered ‘neutral’ for the economy also alters.

Therefore, I believe that the market could have gotten ahead of itself by assuming that the Fed could potentially stop raising rates when it reaches 3%. Hence while the market could be pricing in fewer rate hikes into the price of the US Dollar, there are still chances of the Fed continuing to raise interest rates above 3% if Fed members feel the ‘neutral’ rate has changed based on the economic conditions at that time. This would cause the USD to rally, and hence may be a downside risk for investors in the UDN ETF. However, recent economic data is pointing to a slowing economy. Hence, the chances of the perceived ‘neutral’ rate increasing are quite slim.

Moreover, governor Quarles also mentioned that while the Fed is becoming more data dependent, they would not be react to every single move in economic data, and emphasized that they would focus more on trends in the data developing overtime. Though I believe that recent US economic data is beginning to reflect a weakening trend, specifically from the ‘employment’ perspective.

Jobless claims

The jobless claims report released on Dec. 6 once again surpassed the consensus estimate, coming in at 231,000 vs. 225,000 estimates. Jobless claims numbers have been disappointing over the past several weeks now. This has resulted in the 4-week average trend line indicating a clear upward trend, as shown in the chart below, thereby undermining the strength of the employment conditions. Thus, taking into consideration governor Quarles’s perspective, I believe such concerning trends developing over the past month will encourage Fed members to turn more dovish, thereby easing the rally in the USD, and supporting the UDN ETF higher.

Source: Wall Street Journal

Bottom Line

The outlook for the USD continues to dampen. While the significance of the perceived ‘neutral’ rate is something to ponder about, current economic trends certainly are not supportive of tightening monetary policy conditions. Hence, an increasingly dovish Fed will continue undermining the strength of the USD, and push the UDN ETF higher.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in UDN over 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.