As the Dollar Falls, New Doors Open to Currency Bets

THE dollar’s recent swoon is a textbook example of just how volatile foreign exchange markets can be. The new lows for the dollar brought quick profits to many investors, but the “easy money” has already been made, said Ed Yardeni, the president of Yardeni Research.“Trading in currencies is a dangerous game,” he said. Whether the dollar weakens further or begins to rise will largely depend on what the Federal Reserve does next, he said, and that is very difficult to handicap.This month, the central bank cut its benchmark interest rate by half a percentage point, to 4.75 percent; the cut was bigger than Wall Street had expected. The Fed also reduced the rate it charges banks for emergency short-term loans by half a point.“There is some expectation that there will be more rate cuts,” Mr. Yardeni said. “But I think the Fed was aggressive enough in its recent action that it might not have to cut rates again any time soon.” If the Fed keeps rates as they are, the dollar may stabilize and start trading in a narrow range against some major currencies, like the euro and the Japanese yen, in Mr. Yardeni’s view. That could change the fortunes of investors who have been using a spate of new exchange-traded funds to bet that the dollar will keep falling. These E.T.F.’s have made it much easier for individuals to buy and sell the British pound, the Swiss franc or even the Mexican peso. And some E.T.F.’s allow investors to bet that the dollar will rise or fall against a basket of currencies.Many individual investors have been drawn to these funds. Tim Meyer, the E.T.F. business manager at Rydex Investments, estimated that only about 30 percent of the roughly $1.1 billion that has flowed into the company’s eight currency E.T.F.’s this year was from institutional investors, like pension plans and hedge funds. He said 50 percent probably came through financial planners and the other 20 percent from online brokerage accounts.Rydex Investments, based in Rockville, Md., has created many of the new E.T.F.’s. Each holds currency in a bank account at JPMorgan Chase in London. The funds pay interest, which is based on the overnight money market rate in each currency, minus fund expenses.Although the dollar has fallen against a broad range of currencies this year, Mr. Yardeni said the picture might soon become more complex. The dollar could rise against some major currencies over the next six months, while falling against others, he said, depending on economic conditions and interest rates in each country.For example, the Japanese yen, which has been floundering for years, has surprised investors by rallying against the dollar recently. But Mr. Yardeni said the yen could level off — or even reverse course — unless Japan’s central bank raised the country’s razor-thin interest rates. With fresh signs of deflation in Japan, he said, that may not happen soon.As for the euro, which traded above $1.40 for the first time this month, Mr. Yardeni said he could imagine it going as high as $1.45 but not $1.50. And he predicted that the British pound, now trading at more than twice the value of the dollar, could fall to around $1.85 over the next six months.“We might see a little divergence, where the dollar weakens against the euro and strengthens relative to the pound,” Mr. Yardeni said, because Britain’s economy has a lot of the same risk factors that the American economy does now — including a shaky mortgage market.The currencies with the best outlook are the Australian and Canadian dollars, he said, “because they have what the world wants now, which is raw materials.”Earlier this month, the Canadian dollar reached parity with the American dollar for the first time in more than 30 years. But Mr. Yardeni said he thought both the Canadian and Australian dollars might rise an additional 5 percent or so against the American dollar.Michael Metz, the chief investment strategist at Oppenheimer & Company, said it was too late to buy the British pound or the euro, calling both currencies “grossly overvalued.” He said the Japanese yen was still attractive but not as much as it was in February, when Rydex introduced the CurrencyShares Japanese Yen Trust.“When that E.T.F. was created, the yen was the cheapest currency around,” Mr. Metz said. “But if you want an alternative to the dollar now, I think it’s the Swiss franc.” He said that the Swiss currency had not appreciated in tandem with the euro, largely because Switzerland has lower interest rates.Many investors do not want to pick and choose among foreign currencies, said Bruce Bond, the president and chief executive of PowerShares Capital Management in Wheaton, Ill. PowerShares offers two E.T.F.’s that use futures contracts to make bets on the dollar versus a basket of six currencies: the yen, euro, British pound, Canadian dollar, Swedish krona and Swiss franc. If the dollar rises against these currencies, investors in one of the E.T.F.’s, the PowerShares DB U.S. Dollar Bullish fund, would make money. If the dollar falls, the PowerShares DB U.S. Dollar Bearish fund would come out ahead. Neither fund uses leverage.The company has also created an E.T.F., PowerShares DB G10 Currency Harvest, intended to allow investors to bet against currencies in countries with low interest rates and to take long positions in those with higher rates. Currently, the fund has long positions in the Australian dollar, the New Zealand dollar and the British pound, and short positions in the Japanese yen, the Swiss franc and the Swedish krona.THERE are special tax consequences associated with the three PowerShares funds. Investors who own E.T.F.’s that use derivatives, like futures contracts, have to declare capital gains each year — even if they still own the funds — and 40 percent of the gains will be taxed at the higher rate for short-term capital gains. So experts recommend holding such E.T.F.’s in a tax-advantaged account like an Individual Retirement Account.Alternatively, Mr. Metz said that it might be simpler for investors who are worried about a further decline in the dollar to put a small portion of their portfolios into gold. He recommended one of the E.T.F.’s that invest in actual bars of gold, like the StreetTracks Gold Shares fund or iShares Comex Gold Trust.“I think there will be a big move by central banks to build up their gold reserves, which they have really sold off in recent years,” Mr. Metz said.