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Why there is room for appreciation in the PowerShares DB US Dollar Index Bullish ETF

There is coherence in the idea that The PowerShares DB US Dollar Index Bullish ETF could finally stage one final rally before an eventual breakdown.   Its movement directly correlates with that of the US$ index and what needs ascertaining is that for how long and to what extent could this appreciation last?  This ETF has an inverse exposure to index of USDX future contracts, and like the US$ index, rises in value as the dollar appreciates against a basket of currencies.  It is heavily weighted against the Euro, so strong movements in this constituent currency, will have negative impact on the fund.  With a strong dollar during a major part of 2014 and most of 2015 the performance of this index has been highly dependent on the momentum of the US economy, which has translated into a strong greenback as the $index has imposed itself strongly against other counterpart currencies and has appreciated during this tenor.  During 2016 Euro has been on a lackluster recovery path, and because of its high weightage in the fund, the fund has nonetheless weakened (Figure 1).  Recently, US$ suddenly lost ground against the Euro, in the backdrop of lackluster jobs data, even though much of that was attributable to Verizon strike.  This was not the case when the Eurozone registered hefty uptick in its recently announced GDP data, which poises the region towards an evident path to recovery.  So, it is worth understating once again that PowerShares ETF’s appreciation is intrinsically leverage to the extent of US economic forward momentum as well as the confidence shared by the public on its probable performance which concurrently will help lift the performance of US$ as well. ETF Fund

 

Having made this assertion, there are some question marks about the US economy which could be a deterrent for investing in this fund; the most evident being the funds constant decline during the past year.  The economic crisis of 2002 and 2007 is a testament of how the US$ was affected with a drop in US treasury bond yield curves.  Even though the correlational was not directly proportional, an inverted yield curve, did tend to have long lasting negative impact on the US$, USDX as well as the PowerShares Index fund.  The NAV of this fund has been on a negative gradient (-5.47) since 2015, but then it must be borne to mind that the US$ has been correcting during this time frame as well.  The secular trend has been positive, as the Fund has witnessed a net gain from 2014, at a time when the US$ started a spectacular bull run against the Euro.  Most of 2014 also did witness a positively sloping yield curve, and its true relationship with the US$ index did hold up pretty well.  However, now a different picture is emerging.   Witnessing a plateauing yield curve at a point in time when the US economy is losing some of its steam is unsettling and raises the question about the intrinsic health of the US economy.  The next question coming to mind is what could possibly be the longevity of this plateau? a decline of which could lead to the eventual softening of the US$ index, and along with it the coveted PowerShare ETF.  The 10-year treasury yield have been faltering, and threatening to go into free fall, as they breach the support line (Figure 2).  Yields of this tenor have been negatively correlated to the US$ index strength, and the support line did hold particular significance, and its breaching even more.  Technical analysis of the US$ index does point to a scenario for the ETF to make one final push into a new and a higher frontier, which may be brought by the10-year treasury yields going into stronger free fall, after having convincingly traded below this line of threshold, which would then become a line of resistance.  But in the long run, this would actually add to the demise of the US economy as the yield curve continuously flattens and heads to the edge of a precipice peering down at imminent collapse (Figure 3).  Strong technical grounds for the US$ index to make one final upsurge do exist, but with macroeconomic indicators, in some cases stalling, and the Presidential election entering a penultimate stage, the scenario is set up for a spectacular collapse in the intermediate term.  However, there is little reason to believe that the US economy will suddenly arrest its currently strong, yet slowing, momentum heading into this time zone; but it can certainly do so in the aftermath.

US Treasury Yields, the US$ index and the ETFTerm Structure of Bonds and dollar index movement

Why the US presidential elections hold such great significance is clarified by Bernard Baumohl, a chief economist of the Economic Outlook Group, remark “The chance of a recession depends increasingly on the comfort level Americans have on who sits in the White House next year.” If Donald Trump is elected and decides to refinance the 19 trillion US debt, then it would be beyond a degree of doubt that the long term treasury yields would be strongly hit.  However, with a probability of recession twice as high as last year, a full blown recession may probably be out of the question for now.

 

 Fundamental analysis of the US economy does point to a multitude of factors that can induce economic slowdown.  For example, the economy has been growing at a sluggish pace Probability of Recessionwhich is disallowing it to attain its potential output.  Coupled with this declining business investment is unnerving for many economists and the potential spread of financial contagion from the 2nd largest economy in the worlds poses a probable threat not only to the US economy but the Global economy as well.   And not to say the least, the current manifestation of the yield curve is surely casting dark clouds on the economy and many economists have already started forecasting an imminent recession by 2018.  Reviewing the below stated graph in May the treasury spreads were as low as 1.54% and if prevalent circumstances are to prevail then looking 1 year ahead the probability of recession vastly increases to ~7% (Figure 4).

Probability of Recession deltas

Hindsight data reveals that such a scenario sets up the precedent for rapid increase of probability of recession
(Figure 5), and it is precisely the presence of this scenario at that particular point in time which will truly undermine the authority of the US$ index and an ETF, such as The PowerShares DB US Dollar Index Bullish ETF, which apes its movement.  Investors can remain calm for now as the current state of the economy momentum as well as technical factors in the economy should allow the EFT to transcend higher but it is better to remain forewarned for the upcoming headwinds.

 

 

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