The Invesco DB USD Bullish ETF (UUP), which tracks the USD against six major global currencies, has rallied by about 10% since February of this year, mainly thanks to a hawkish Fed. New revised Gross Domestic Product (GDP) data has come in for the third quarter (Q3), which allows for further assessments on whether the Fed should continue hiking rates based on economic performance and whether you should buy or sell UUP.
(Source: Yahoo Finance)
Prospectus Review
The ETF seeks to establish long positions in the ICE U.S. Dollar Index futures contracts to track changes in the level of the Deutsche Bank Long USD Currency Portfolio Index. The fund has an expense ratio of 0.76%.
The holdings of the UUP are:
|
UUP Holdings |
Percentage of portfolio |
|
Futures Dollar Index Dec18 |
50.01% |
|
United States Treasury Bills |
13.04% |
|
CLTL – Invesco Treasury Collateral Portfolio ETF |
7.29% |
Risk Note: It is possible that the Fund’s performance may not fully replicate the changes in the levels of the Index due to disruptions in the markets for the relevant Index Currencies, the DX Contracts, or due to other extraordinary circumstances. The Managing Owner may determine to invest in other futures contracts if at any time it is impractical or inefficient to gain full or partial exposure to the Index Currencies through the DX Contracts.
The distinctive reason I have chosen to write about this particular ETF is because it is one of the most well-diversified ETFs out there that track the USD. It tracks the USD against various different currencies of developed countries, namely the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
Q3 GDP Revision
A second estimate for Q3 GDP was released on November 28, 2018, which came in unchanged at 3.5%. This is a strong level of growth, which could encourage the Fed to continue raising interest rates and drive UUP higher. Nevertheless, while the headline figure looks strong, let’s dig deeper into the report to examine how the US economy is performing.
While the headline figure remained the same at 3.5%, consumer spending was revised downwards from 4% to only 3.6% growth. Given that consumer spending accounts for 70% of the US economy, this drop-off is certainly concerning.
The decline in consumer spending was offset by increased business spending on inventory, which was revised from $76.3 billion up to $86.6 billion. In fact, it boosted GDP growth by 2.27% in Q3. However, investors should note that this increased spending was mainly driven by fear of increased tariffs by the Trump administration on foreign goods, which encouraged businesses to stockpile inventory in order to avoid excess charges on importing these goods. Hence, my expectation is that the strong inventory spending of last quarter may turn out to be a short-term factor, and could even result in lower inventory spending in Q4 due to the already strong inventory stockpiles built up, which could end up hurting the Q4 GDP figure. Therefore, this anticipated bearish factor could discourage the Fed from raising rates aggressively, which would weaken the USD and drag UUP lower.
Moreover, the fact that those businesses were importing more inventory goods resulted in imports increasing faster than exports in Q3, leading to a higher trade deficit. Exports, particularly soybeans, were hurt by Chinese tariffs. The widening trade deficit decreased the GDP figure by 1.91%. It does not seem like the trade tensions between the US and China are going away anytime soon. Hence, continued weakness in exports could persistently weigh down the GDP over the next few quarters at least. This factor of the GDP report is also not supportive for the Fed to remain hawkish, and will definitely pull the USD and UUP lower.
In fact, Q4 GDP is estimated to slow down to 2.5%. It has already slowed down in Q3, in comparison to the 4.2% growth rate in Q2. Therefore, the continued slowdown in economic growth means the Fed will have to continue shifting towards a more dovish stance.
Bottom Line
While the headline GDP figure may look good, underlying factors do not reflect a very strong economy. Moreover, factors such as trade tensions and weaker consumer spending do not seem to be fading away, which further weakens the economic outlook going forward. Therefore, I believe the new GDP data for Q3 will further encourage the Fed to tone down its hawkishness and make more efforts to support the economy going into 2019. This will translate into a weaker USD and will derail the rally in UUP. I recommend selling out of any long positions in UUP.
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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