FX Long-term valuation G10 currencies

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Susan Davis
5 years ago
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1 FX Long-term valuation G10 currencies 17 February 2017 GBP: By far, Sterling is the most undervalued of G10 currencies, in trade weighted terms standing almost 20% below its long-term fair value (LTFV) and by over 30% against the most expensive currencies (AUD, NZD), which is simply unsustainable. However, so long as Brexit uncertainty the reason for its present weakness persists, a more substantial recovery is unlikely, although scope for further depreciation seems limited. SEK perspective: Moreover, with GBP s LTFV against SEK at its current deviation (11%) is hardly extreme. Indeed, with GBP/SEK previously deviating by as much as 20-25% from our LTFV estimate, its present valuation provides no reason why we should not expect GBP to depreciate further against the SEK, although mostly this must result from more general appreciation by the krona. NOK: The NOK has recovered substantially since the beginning of 2016 when it was more than 20% undervalued in trade weighted terms compared to our LTFV estimate. While partly, this reflects an adjustment to the LTFV, mostly it reflects a recovery in the spot exchange rate. Still, the NOK remains somewhat undervalued against commodity currencies (AUD, NZD) and the USD. SEK perspective: The present NOK/SEK spot rate is 1.07, largely in line with our LTFV estimate of 1.09, suggesting little likely future movement in the pair absent changes in market conditions or economic conditions. EUR: In trade weighted terms the common currency lies fairly close to its LTFV, being only slightly overvalued today. However, the euro remains slightly cheap vs. the dollar with its equilibrium exchange rate against the greenback at SEK perspective: EUR/SEK was substantially overvalued when it traded above in Q4 last year, compared to our LTFV estimate of However, the subsequent SEK recovery has eliminated almost half this stretch. Clearly levels above 9.70 would be very attractive for selling EUR/SEK. USD: Our LTFV estimates show that in trade weighted terms the USD is presently one of the most overvalued G10 currencies, surpassed only by its smaller commodity related counterparts. Except for the GBP, which is 25% undervalued against the dollar, most other G10 currencies, however, trade well inside their historical ranges compared to their LTFV. For example, the euro and yen are approximately 10% undervalued against the greenback. In the longer term it is reasonable to expect the dollar to correct lower against most currencies. SEK perspective: Our USD/SEK LTFV estimate is around 7.75, largely unchanged since 1993 when the krona began to float. Our estimate indicates the krona currently is almost 15% undervalued against the dollar, providing opportunities to buy the SEK at a long-term attractive level. AUD, NZD: At present, the commodity currencies are more overvalued than any of their G10 counterparts at 15% in trade weighted terms, almost as much as they were a couple of years ago before they corrected substantially lower due to weaker commodity prices and rate cuts from the central banks. Partly, their past year s recovery probably reflects such fundamentals as above average growth and rising commodity prices, but also the attractive yield offered by the AUD and NZD compared to most other currencies has contributed. Although both are still substantially overvalued, they are less so than a few years ago. Eventually they will correct lower against virtually all other G10 counterparts, but probably not just yet. SEK-perspective: Generally the krona has been undervalued against commodity currencies since they strengthened rapidly in However, as deviations of more than 20% from our LTFV estimates have never been long-term sustainable previously, we expect a correction lower in the foreseeable future although it might be too early just yet. One problem that stands in the way of those looking to use this opportunity to buy the SEK against commodity currencies is a negative carry. Currently, the one-year forward prices are almost 20 figs below the spot prices in AUD/SEK and NZD/SEK. Richard Falkenhäll

2 Long-term valuation TWI TWI Long-term valuation (G10) Ccy pair Dev. from LTFV Undervalued Overvalued GBP -18% NOK -6% SEK -4% JPY -4% CAD -1% EUR 3% CHF 6% USD 9% AUD 15% NZD 15% This report provides estimates of equilibrium exchange rates for the 10 most traded global currencies (G10). Long-term fair value (LTFV) estimates used in this report represent the average of two different empirical approaches to estimate the equilibrium exchange rate or the fair value for each currency: 1) SEBEER Long-term fair value model: Fundamental variables are important in determining the equilibrium exchange rate. To capture the long term equilibrium exchange rate we have used a reduced form equation where the LTFV is determined by a finite number of fundamental variables (relative prices (PPP), terms of trade, relative productivity, and real long-term interest rate differentials). The SEBEER model uses a panel of annual observations for 29 currencies against the USD between 1980 and To maintain consistency, LTFVs for other currency pairs are simply obtained using calculations on estimates for USD-crosses. 2) Long-term trend: Currencies tend to be mean-reverting, which means that exchange rates appear to gravitate towards historical averages or towards long-term trends (in nominal exchange rates). This longterm trend in each currency against the USD is applied as an alternative measure of the equilibrium exchange rate. Generally currencies tend to deviate more or less from their LTFVs. These deviations may be sustained for fairly long periods due to one or more factors. However, in most cases deviations of 20% or 30% indicate an unsustainable stretch, when it would be reasonable to expect the exchange rate eventually to experience a more substantial correction towards its equilibrium level. NOTE: All charts in this report are constructed such that a deviation below the estimated fair value indicates overvaluation and above indicates undervaluation of the currency.

3 Long-term valuation TWI

4 SEK Long-term valuation SEK Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/SEK % % USD/SEK % % NOK/SEK % % GBP/SEK % % JPY/SEK % % AUD/SEK % % NZD/SEK % % CAD/SEK % % CHF/SEK % % SEK TWI % - -

5 SEK Long-term valuation

6 NOK Long-term valuation NOK Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/NOK % % USD/NOK % % NOK/SEK % % GBP/NOK % % JPY/NOK % % AUD/NOK % % NZD/NOK % % CAD/NOK % % CHF/NOK % % NOK TWI % - -

7 NOK Long-term valuation

8 EUR Long-term valuation EUR Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/USD % % EUR/SEK % % EUR/NOK % % EUR/GBP % % EUR/JPY % % EUR/AUD % % EUR/NZD % % EUR/CAD % % EUR/CHF % % EUR TWI % - -

9 EUR Long-term valuation

10 USD Long-term valuation USD Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/USD % % USD/SEK % % USD/NOK % % GBP/USD % % USD/JPY % % AUD/USD % % NZD/USD % % USD/CAD % % USD/CHF % % USD TWI % - -

11 USD Long-term valuation

12 GBP Long-term valuation GBP Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/GBP % % GBP/SEK % % GBP/NOK % % GBP/USD % % GBP/JPY % % GBP/AUD % % GBP/NZD % % GBP/CAD % % GBP/CHF % % GBP TWI % - -

13 GBP Long-term valuation

14 JPY Long-term valuation JPY Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/JPY % % USD/JPY % % JPY/SEK % % GBP/JPY % % JPY/NOK % % AUD/JPY % % NZD/JPY % % CAD/JPY % % CHF/JPY % % JPY TWI % - -

15 JPY Long-term valuation

16 AUD Long-term valuation AUD Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/AUD % % AUD/SEK % % AUD/NOK % % AUD/USD % % AUD/JPY % % GBP/AUD % % AUD/NZD % % AUD/CAD % % AUD/CHF % % AUD TWI % - -

17 AUD Long-term valuation

18 NZD Long-term valuation NZD Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/NZD % % NZD/SEK % % NZD/NOK % % NZD/USD % % NZD/JPY % % GBP/NZD % % AUD/NZD % % NZD/CAD % % NZD/CHF % % NZD TWI % - -

19 NZD Long-term valuation

20 CAD Long-term valuation CAD Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/CAD % % CAD/SEK % % CAD/NOK % % USD/CAD % % CAD/JPY % % GBP/CAD % % AUD/CAD % % NZD/CAD % % CAD/CHF % % CAD TWI % - -

21 CAD Long-term valuation

22 CHF Long-term valuation CHF Long-term valuation Ccy pair LTFV Spot Dev. Spot 12m fwd Dev. Fwd EUR/CHF % % CHF/SEK % % CHF/NOK % % USD/CHF % % CHF/JPY % % GBP/CHF % % AUD/CHF % % NZD/CHF % % CAD/CHF % % CHF TWI % - -

23 CHF Long-term valuation

24 Disclaimer

FX Long-term valuation

FX Long-term valuation 7 February 2018 Although the GBP recovered against several currencies in 2017 it remains the most undervalued currency in trade weighted terms among all G10 currencies (-17% rel.