The U.S. dollar index is trading at its lowest levels in eight months, as growth prospects for fourth-quarter GDP have been dampened by the government shutdown and the Federal Reserve is now expected to delay the tapering of its bond-buying program until as late as the end of the first quarter of 2014. Reductions in the Fed's asset purchases (still at $85 billion per month) are generally considereda negative for stock benchmarks and a positive for the U.S. dollar. However, larger-than-expected costs resulting from the U.S. government shutdown complicate the Federal Reserve's ability to accurately assess the state of the economy.
"Delays in key economic data and a broader reluctance to inject fresh volatility in already-vulnerable markets will likely tie the hands of voting members at the Fed," said Haris Constantinou, currency analyst at TeleTrade. "This makes it difficult for the central bank to enact sweeping changes in monetary policy." Since a steady supply of stimulus injections is bearish for the dollar and assets tied to its value, recent events will make it difficult for the PowerShares DB US Dollar Index Bullish ETF (NYSEMKT:UUP) to make significant headway before the end of the year.
Looking for gains in high-yielders
Relative inactivity at the Fed will bring some additional stability to the market and reduce the larger need to invest in safe-haven currencies. This will benefit assets tracking the value of high-yielders such as the New Zealand and Australian dollar. ETF investors looking to buy into the expected bullish moves in these currencies should consider two exchange-traded funds: the WisdomTree Dreyfus Australia & New Zealand Debt Fund (NYSEMKT:AUNZ) and the CurrencyShares Australian Dollar Trust (NYSEMKT:FXA) as viable alternatives to assets denominated in U.S. dollars.
The benchmark interest rate in both Australia and New Zealand stands at 2.5%. This might seem relatively low (in fact, interest rates in Australia are now at historic lows), but when looking at developed-market counterparts, these are the highest carry returns you'll find. The added yield incentive that accompanies investments in these currencies will likely support market valuations as investors are able to hold longer-term positions through periods of potential volatility. So long as we continue to see central banks committed to stimulus programs, however, investors will be more willing to accept the added risk that accompanies positions in assets with higher-rate yields.
All eyes on the Fed
Ultimately, the fate of the U.S. dollar rests on the Fed and its level of concern for economic-growth prospects and generalized market stability. By some estimates, the extended government shutdown cost the U.S. economy $24 billion in potential fourth-quarter productivity. The schedule delays that will be seen in critical data reports (such as manufacturing and employment) make it highly unlikely that the Fed will see enough information to start making changes in monetary policy.
The Fed's quantitative-easing programs are designed to reduce long-term borrowing rates, spur consumer spending, and fuel risk appetite. At the same time, these types of programs debase the currency. The PowerShares DB US Dollar Index Bullish ETF has responded accordingly, falling by more than 5% since July.
Recent comments from voting members at the Federal Reserve have gone far to reverse prior tapering expectations (which had originally called for reductions in stimulus to be announced at this year's September meeting). Until we see Fed comments suggesting that the economy is ready to operate independently, expect the U.S. dollar to continue to face selling pressure that benefits its higher-yielding counterparts.
Richard Cox has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.