Economists believe the dollar will keep rallying in the near-term for two reasons. First, the U.S. economy is the fastest-growing in the developed world, which is attracting global asset flows onto our shores.
Second, the U.S. Federal Reserve is reputedly on the cusp of a tightening cycle. When that happens, “capital flows should favor U.S. Treasuries over lower-yielding German Bunds and other sovereign debt, strengthening the U.S. dollar even further,” Dodd Kittsley, Deutsche Bank’s head of ETF strategy, wrote in a recent blog post. Kittsley scoffs at the notion that the dollar has overshot the mark and is due to weaken. “While the trade-weighted dollar has appreciated 14 percent over the past four years, it remains far below its historical highs.”
If and when the Fed does start to raise rates, these hedged ETFs should actually benefit. “Higher interest rate differentials lead to income streams for the ETFs as forward currency contracts gain in value,” says Jeremy Schwartz, research director at WisdomTree Investments. That gain should help mitigate the expense ratios at these funds, which stand at 0.58 percent and 0.45 percent for HEDJ and DBEU, respectively.
Schwartz believes currency-hedged ETFs are not just a fad, but instead will likely remain in favor over the long haul. “Most people have historically assumed currency risk in building global portfolio exposure, but why would you ever want exposure to the euro?” he asks.
The HEDJ and DBEU funds have delivered what they have promised over the past few quarters. And the stars are aligned for continued outperformance in the near-term. Yet these aren’t set-it-and-forget-it ETFs. European stock valuations already reflect some of the anticipated European economic upturn. At some point, trend-oriented investors will yank money out of these funds, and shift into lower-cost ETFs to retain their long-term European exposure.