Three Way to Play the Dollar Carry Trade

This post is part of a regular series written by ETF Trends editor Tom Lydon, special for CNBC.com.

A Federal funds rate near zero, monetary easing and government purchases of long-term debt have given rise to a carry trade of the U.S. dollar. The carry trade is a strategy in which an investor sells one currency with a relatively low interest rate, then uses that money to purchase a different currency that’s yielding higher. The investor then pockets the difference between the rates.

Spotlight on Commodity ETFs
Spotlight on Commodity ETFs   

Why should investors be watching this as it plays out?

While many analysts fear that this is creating an asset bubble that’s ready to pop, the dollar carry trade isn’t likely to end anytime soon. It would require the Federal Reserve to raise rates, and most feel that this isn’t going to happen until the second or third quarter of 2010.

(Ultra-bear Nouriel Roubini weighs in:'Mother of All Carry Trades' Will Lead to 'Asset Bust')

U.S. investors have to realize that investing overseas is not unpatriotic. While an allocation to overseas markets greater than 20 percent is deemed aggressive, that’s really not the case. The fact is that 50 percent of global GDP is coming from emerging markets, and two-thirds of the global market capitalization lies outside the United States.

While the dollar may continue to suffer and the United States loses significance in the global landscape, three exchange-traded funds (ETFs) can give you the chance to profit as the dollar carry trade continues apace:

- PowerShares DB G10 Currency Harvest: Holds long futures for three currencies with highest interest rates; short futures for three currencies with the lowest interest rates; this fund is considered a diversified play on the carry trade

- iShares MSCI Emerging Markets: Analysts believe that emerging markets are going to continue to lead the way out of a recession

- CurrencyShares Euro Trust: Eurozone interest rates are currently at 1 percent

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Tom Lydon is the editor of ETF Trends and author of iMoney: Profitable ETF Strategies for Every Investor.

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