FX Long-term valuation

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Claude Darren Parker
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1 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. LTFV). It is followed by the JPY as the second most undervalued currency (-13% rel. LTFV). On the other extreme the EUR singles out as the most overvalued currency in trade weighted terms (12% rel. LTFV). Just a year ago, by the end of 2016, the euro traded around its long-term fair value. Among the rest of the currencies the AUD and the NZD remain overvalued while the USD has moved significantly and now trade roughly in line with our LTFV-estimate in trade weighted terms. SEK: Despite its weakness against the euro in 2017 the krona moved towards its LTFVs against most currencies last year, being less undervalued today than what our model suggested a year ago. In particular the dollar weakness has moved USD/SEK close to the LTFV-estimate. GBP and JPY are the two exceptions where spot rates have moved away from our long-term fair value estimates. AUD, NZD and EUR are the most overvalued currencies against the krona, deviating by around 10% from our long-term fair value estimates vs the SEK. NOK: The Norwegian krone has moved in a similar fashion as the SEK over the last year, moving towards its longterm fair value estimates against most currencies. AUD, NZD and the euro are currently the most overvalued currencies against NOK. EUR: After appreciating significantly in 2017 the euro today appear as the most overvalued currency in trade weighted terms among all G10 currencies. In particular against the dollar the change has been substantial since from a year ago when the euro was around 10% undervalued against the dollar. Today it is instead around 5% overvalued. Largest stretches are against the JPY and the GBP where the euro is around 20% overvalued. Usually stretches of this size suggest an increased likelihood of substantial corrections. USD: The dollar has corrected towards its long-term fair values in most currency pairs during the last year. Today the trade weighted dollar index is very close to our long-term fair value estimate. After the correction it moreover trades quite close to the LTFV against the euro at 1.18, while it remains overvalued against the JPY with the LTFV at 97. The extreme stretch in GBP/USD where the spot rate deviated by more than 20% previously has now started to correct towards the LTFV of GBP: Exposed to the Brexit risk premium the GBP remains undervalued against most currencies except the JPY. As the GBP recovered slightly in 2017 stretches are generally smaller today than a year ago. The euro is one exception though. We have added long-term fair value estimates for PLN, RUB and TRY. These are based on their long-term trends in nominal exchange rates against the dollar. With long-term fair value in EUR/PLN at 3.82 the zloty is still undervalued against the euro while it trades close to its long-term fair value against several other currencies like the SEK and the USD. The LTFV estimate for RUB is associated with substantial uncertainty but it appears to be close to its long-term fair values against several currencies. Probably the RUB is slightly undervalued against the euro while it trades close to LTFV against the dollar. Finally, our estimates suggest that TRY remains undervalued against most currencies. Last year the undervaluation in fact seemed to increase further. Deviation from LTFV against the euro is currently almost 20% while the TRY trades 15% below its estimated fair value versus the dollar. Richard Falkenhäll

2 Long-term valuation TWI TWI Long-term valuation, Feb and Dec Ccy pair Dev. from LTFV Undervalued Overvalued GBP -17% JPY -13% NOK -5% SEK -4% CHF 0% CAD 1% USD 2% AUD 11% NZD 11% EUR 12% 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. 2

3 Long-term valuation TWI 3

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 % - - 4

5 SEK Long-term valuation 5

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 % - - 6

7 NOK Long-term valuation 7

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 % - - 8

9 EUR Long-term valuation 9

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 11

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 % 152 3% GBP/AUD % % GBP/NZD % % GBP/CAD % % GBP/CHF % % GBP TWI %

13 GBP Long-term valuation 13

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 15

16 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 %

17 CHF Long-term valuation 17

18 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 %

19 AUD Long-term valuation 19

20 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 %

21 NZD Long-term valuation 21

22 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 %

23 CAD Long-term valuation 23

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

25 PLN Long-term valuation 25

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

27 RUB Long-term valuation 27

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

29 TRY Long-term valuation 29

30 Disclaimer 30

FX Long-term valuation G10 currencies

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)