The currency hedging trade is starting to fade

Euro Dollar Yen
Kiyoshi Ota | Bloomberg | Getty Images

The trendiest trade of 2015 has lost some of its mojo lately.

With global central banks in overdrive to devalue and the U.S. heading in the opposite direction, investors had been piling into exchange-traded funds that hedged against big currency moves.

Four of the top 10 ETFs this year in terms of fund inflows are related to currency hedging. That includes the most popular one, the WisdomTree Europe Hedged Equity, which has taken in $13.6 billion, according to ETF.com. The fund is up a gaudy 16.8 percent year to date but is down 2.5 percent over the past week and off 0.4 percent for the month.

The funds often use a balance of dividend-paying and export-based companies to hedge currency exposure.

Softening economic conditions and the derailing of U.S. dollar strength has turned the tide on the currency hedge play.

During May, currency hedged funds saw their slowest pace of inflows since October, with just $3.4 billion coming into those products, reported BlackRock, which is the biggest player in the ETF industry with $822.2 billion in assets under management. Investor interest grew a bit later in the month when the greenback regained some strength, but likely will wane again now that the dollar is headed weaker.

Central bank positioning will be the key.

ECB: no plans to change monetary policy
ECB: No plans to change monetary policy   

Investors earlier in the year began making bets that the U.S. Federal Reserve was on a certain path toward tightening. However, mediocre economic conditions have led to a belief that the Fed will wait until later in the year, or perhaps even into 2016, before it begins hiking rates.

Read MoreIMF cuts US forecast, calls for rate hike delay

With the climate uncertain, the best place for investors may be on the sidelines.

''In a rising dollar environment, there is definitely a benefit to using those hedge strategies," said Christopher Vecchio, currency analyst at DailyFX. "But right now with the dollar treading water, it puts a little uncertainty into whether those are absolutely necessary. For the time being traders, as the euro looks for direction, are probably going to be a little bit more reticent about using those exchange-traded funds."

Vecchio said currency traders actually are probably more focused on what the European Central Bank is doing rather than the Fed. ECB President Mario Draghi indicated Wednesday that he felt rising German bund yields were more a result of improving economic conditions than monetary easing by his institution.

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Consequently, markets took that to mean that the ECB won't be amping up its quantitative easing program soon. That in turn put upward pressure on the euro and yields, and downward pressure on the U.S. dollar.

So while funds that hedge on yen movements remain popular, inflows to euro-focused hedging have decelerated.

Interestingly, WisdomTree on Thursday announced two new funds that focus on currency hedging, the WisdomTree International Hedged SmallCap Dividend Fund, which will trade under the ticker HDLS, and the WisdomTree Global ex-U.S. Hedged Dividend Fund, or the DXUS. WisdomTree has $63.2 billion in ETFs under management, making it the fifth-largest player in the $2.1 trillion industry.