Race To The Bottom For European Currency ETFs

With more and more signs pointing to a December rate hike by the Federal Reserve and more traders willing to bet such an event is going to happen, the divergence in developed markets central bank policies becomes more apparent by the day.

Currency-based exchange traded funds prove as much. As has been noted in this space several times in recent days, dollar ETFs, namely the PowerShares DB US Dollar Index Bullish UUP and the WisdomTree Bloomberg U.S. Dollar Bullish Fund USDU, have recently been setting torrid paces. Just two ETFs hit all-time highs Wednesday and USDU is one of those two. UUP, the U.S. Dollar Index tracking ETF, resides about two percent below its 52-week high.

For dollar bulls (and bears), it feels like it is all about the Fed, but that may not be the case because the UUP and USDU can keep soaring even if the Fed surprises and stands pat on interest rates next month. The reason is simple: Central banks Europe, notably the European Central Bank and the Swiss National Bank, appear poised to cut interest rates as well.

"The ECB rate path is pricing in the certainty of a 10 bps cut to the deposit rate at the December 3^rd meeting to -0.30% from -0.20%. However, the market is pricing in the near certainty of another 10 bps cut at some point in the first half of next year to -0.40%," said Rareview Macro founder Neil Azous in a note out Wednesday.

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More easing by ECB, predictably, means more pain for the already downtrodden CurrencyShares Euro Currency Trust FXE. Down 12.5 percent year-to-date, FXE currently resides just 1.1 percent above its 52-week low, which was set in March.

FXE's struggles have been a boon for the ProShares Short Euro EUFX, an inverse though not leveraged ETF designed to rise as the euro falls against the U.S. dollar. Up nearly 12 percent year-to-date, EUFX has been somewhat overlooked by ETF traders. At least almost $15 million in fourth-quarter outflows say as much. That means EUFX has less than $20 million in assets under management, a number that is either too small or destined to rise if the ECB continues with its easing efforts.

The CurrencyShares Swiss Franc Trust FXF is another developed market currency ETF that is in trouble. SNB, Switzerland's central bank, has shown a willingness to fight ECB when it comes to currency devaluation. FXF hit a 52-week low Wednesday and that is unlikely to be the end of the ETF's downside.

"The SNB rate path is pricing in a 100% probability of a 25 bps cut to the deposit rate at the December 10 meeting to -1.00% from -0.75% and a 60% chance of a second 25 bps cut sometime in the first half of 2016 all the way to -1.25% from -1.00%," adds Azous.

Here is something interesting regarding FXF and FXE: Although FXF came into Wednesday with a year-to-date loss of less than 3 percent, that ETF has been nearly twice as volatile as FXE.