Why & How To Trade The Soaring Euro With ETFs

The euro has been on a tear lately, being at a six-month high against the greenback in early May. In the last three months (as of May 22, 2017), CurrencyShares Euro ETF (NYSE:FXE) FXE was up about 6.4% while the greenback ETF PowerShares DB US Dollar Bullish ETF (NYSE:UUP) UUP lost about 4.4%.

Inside the Euro Rally

Several reasons are behind this rally. Below we highlight a few and find if the rally has legs.

Improving Euro zone Economy

The Euro zone saw a strong start to the year thanks to economic improvement and upbeat corporate earnings. The Eurozone economy grew 0.5% sequentially in Q1 of 2017, meeting market expectations. The region also expanded faster than the U.S. in 2016 for the first time since 2008.

Ebbing Political Risks

Euro zone's second-largest economy – France – chose Centrist and business-friendly candidate Emmanuel Macron as its president in a run-off election in early May. With this, France followed the footsteps of the Dutch and discarded populism. All these have lowered the growing upheaval in European politics to a large extent (read: French Election Soothes Sentiments: ETFs Likely to Benefit).

Compelling Valuation

In early December 2016, the common currency Euro plummeted to a 20-month low following the results of Italy’s constitutional referendum which indicated political uncertainty. This kept euro’s value at check and gave the currency room to run (read: What Does Italy Referendum Mean for These ETFs?)

Looming ECB Policy Tightening?

Though the ECB is practicing a QE policy along with rock-bottom interest rates, a steady improvement in the region may lead the central bank to tighten policy in the near term. Already German Deputy Finance Minister commented that “the European Central Bank should begin unwinding its ultra-loose monetary policy soon if it wants to avoid damaging side-effects.”

Consumer prices in the euro area grew 1.9% year over year in April 2017, more than 1.5% growth in March. This improving trend gives cues that the ECB may not ease further and so the currency euro is less likely to depreciate meaningfully ahead. This case opens the door for Euro ETF investing.

Fading Trump Trade in the U.S.

With Trump facing several allegations related to his Russia connections, chances of the President’s success in pushing through his pro-growth pledges are now dimming (read: Best ETF Strategies for Trump Uncertainty).

Plus, overvaluation concerns in U.S. stocks and some weaker-than-expected economic data led U.S. Treasury yields to remain subdued in recent sessions. In fact, the difference between U.S. and German government bond yields “reached itsnarrowest in more than six months” on May 17, 2017. Trump uncertainty may in fact lower chances of faster-than-expected Fed rate hikes. The U.S. dollar slid to a six-month low and Euro soared against the greenback.

Euro ETFs in Focus

There are ETFs like FXE and Ultra Euro ETF (LON:ULE) to go long on Euro. The funds FXE and ULE have a positive weighted average of 1.40 and 1.38, respectively. Since positive weighted alpha points at more gains, Euro ETFs may soar ahead.

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