UUP: Dollar Trends Could Guide Broader Markets

ETFS

The Invesco DB USD Index Bullish Fund (NYSEARCA:UUP) has moved to levels that are near the highs from last October and macroeconomic trends suggest that these gains have the potential to continue. Key event factors in several different countries have positioned trading scenarios in ways that support the bullish outlook for this U.S. dollar-based ETF, which tracks the weighted value of the greenback against six different currencies in various global regions:

Source: ETFdb

A significant majority of the fund (71.2%) is impacted by economic developments in the eurozone and in Japan, and both regions are likely to see currency valuations negatively influenced by long-term monetary policy decisions and recent changes in economic data. The Japanese yen recently fell below the 111.50 mark against the U.S. dollar, which is its weakest valuation since the middle of 2019. These declines came after the Japanese economy posted its worst contraction in nearly six years, as weaker productivity levels have resulted from various deficiencies:

Source: Trading Economics

Following a destructive tycoon season and a raise in national tax requirements, we can see that the country is facing potentially disruptive economic issues in several different directions. As the prospects of recession in the world’s third-largest economy loom large, these are conditions that are likely to weigh on the yen in the weeks and months ahead. Eurozone economic figures have also experienced some turbulence.

In Germany, consumer confidence levels are dropping and continued health concerns in Asia threaten the outlook for the export-centered economy. Germany’s GfK consumer climate index (forward-looking) is clearly below the important 10-threshold and this gives us an idea of the performance trends that are likely to be seen over the next few months:

Source: Trading Economics

This contrasts with what is still a picture that is largely favorable for the U.S. economy, as regional housing data indicate unexpected stability in the construction of new homes and housing permits have reached their highest levels in more than a decade. Essentially, this indicates a much more positive outlook as a period of low mortgage rates has generated strength in the housing market that has proven to be sustainable.

In addition to this, economic reports from the services and manufacturing sectors have started to turn higher after a period of questionable trend activity. In January, the Institute of Supply Management’s manufacturing survey rose to 50.9 and the figures from December were revised higher to 47.8. Economic trend differences here are significant because the index is understood to be expanding in growth with readings above 50:

Source: Trading Economics

Similar trends are visible in the ISM services index, which beat analyst estimates and rose to 55.5 for the month of January (an increase from 54.9 in December). This side of the index has shown solid expansion for most of the last decade and it suggests that the broader economy is positioned for further growth:

Source: Trading Economics

Economic figures that are most closely followed by investors tend to be related to labor markets and these numbers have also remained strong with the addition of 225,000 new jobs in the U.S. during the month of January. This is an indication that American workers are returning to the labor force and improvements in wage growth have also supported the validity of the recent labor market gains.

Source: Tradingview

For the Federal Reserve, policy decisions are often swayed by strength or weakness in the labor market and this makes it less likely that the U.S. central bank will act in ways that might be detrimental to dollar-based assets. These are forces that have the UUP trading above important resistance levels but most of the fundamental indicators suggest the bull trend can continue.

Overall, I expect dips in UUP to be mostly limited as short-term cyclical developments. But the broader market may also take its cues from trend broader direction in this ETF as stock markets have reached excessive valuations and the Federal Reserve has the potential to become the next big player in determining where this bull market in equities finally ends.

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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.

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