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The U.S. dollar surged to a nearly two-year high against the basket of other currencies driven by a hawkish Fed. A strong dollar will lead to a rally in the stock market as it attracts foreign money from investors seeking dollar-denominated returns instead of their home currencies. Additionally, it provides an edge to the domestic-focused companies.

This is because energy cost in America decreases with a strong dollar, thereby lowering the industrial cost and improving profitability as well as the overall economy. Investors seeking to make a play from this trend could consider ETFs such as Invesco DB US Dollar Index Bullish Fund (UUP), WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU), iShares Russell 2000 ETF (IWM) and iShares Currency Hedged MSCI EAFE ETF (HEFA).

Inside the Dollar Surge

The Federal Reserve raised the interest rates by 25 bps for the first time in three years and is expected to follow a more aggressive path in raising rates to fight the 40-year high inflation. Fed Chair Jerome Powell showed confidence that the American economy is strong enough to withstand a tighter monetary policy. The move indicates a a healthy economy and is expected to pull in more capital into the country and lead to the appreciation of the U.S. dollar.

The latest Fed minutes showed the expectations of multiple half percentage-point rate increases to control soaring inflation. Federal Reserve Governor Lael Brainard indicated an aggressive approach to shrinking the central bank’s balance sheet. He hinted that the central bank will start “to reduce the balance sheet at a rapid pace as soon as May meeting.” The current pricing suggests a 0.5% bps hike in May and a cumulative boost of 2.5% to the benchmark rates through the end of the year, from the near-zero level at the start of 2022.

Fed funds futures traders expect the Fed's benchmark rate to rise to 2.60% by February from the current 0.33% According to the CME Group's FedWatch, traders are betting on half-point moves higher in the Fed Funds rate at the next three Fed meetings in May, June and July.

Let’s now discuss the ETFs in detail below:

UUP

Invesco DB US Dollar Index Bullish Fund is the prime beneficiary of the rising dollar as it offers exposure against a basket of six world currencies. This is done by tracking the Deutsche Bank Long USD Currency Portfolio Index - Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities. In terms of holdings, Invesco DB US Dollar Index Bullish Fund allocates nearly 57.6% in euro and 25.5% collectively in the Japanese yen and British pound.

The fund has so far managed an asset base of $993.2 million while seeing an average daily volume of around 1.8 million shares. UUP charges 78 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

USDU

WisdomTree Bloomberg U.S. Dollar Bullish Fund is another way to play the rise in dollar directly. It offers exposure to the U.S. dollar against a basket of foreign currencies by tracking the Bloomberg Dollar Total Return Index. WisdomTree Bloomberg U.S. Dollar Bullish Fund exhibits strong negative correlations to international equity and bond portfolios.

WisdomTree Bloomberg U.S. Dollar Bullish Fund has amassed $436.7 million in AUM and trades in a lower volume of about 346,000 shares per day on average. It charges 50 bps in annual fees.

IWM

A strong dollar provides an edge to the domestic-focused companies as small caps do not have much exposure to the international market. iShares Russell 2000 ETF will benefit from a rising dollar. It provides exposure to a broad basket of 2,0215 stocks by tracking the Russell 2000 Index, with none holding more than 0.52% of assets. iShares Russell 2000 ETF is the most popular and liquid choice in the small-cap space, with AUM of $60.1 billion and an average trading volume of around 28.1 million shares.

iShares Russell 2000 ETF charges 19 bps in annual fees and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

HEFA

The strength in the greenback would compel investors to recycle their portfolios into the currency-hedged ETFs. For those seeking exposure to the developed market, iShares Currency Hedged MSCI EAFE ETF could be an intriguing pick. It targets the developed international stock market in Europe, Australasia, and the Far East with no currency risk. iShares Currency Hedged MSCI EAFE ETF tracks the MSCI EAFE 100% Hedged to USD Index.

The fund has AUM of $3.4 billion and trades in a solid volume of 708,000 shares. HEFA charges 35 bps in fees per year from investors and has a Zacks ETF Rank #3 with a Medium risk outlook.