Valuation In FX

The Economist recently published an update of their popular Big Mac measure of purchasing power parity. One of the key metrics behind our conviction in late '07 that the dollar was poised to rally was the fact that on PPP basis the dollar's bilateral exchange rates were stretched more than ever. The dollar's rise began against sterling and Canada in late '07 and then Swiss in March 08 and finally the euro in July 08. The acute financial crisis saw bilateral pairs move close to fair value as measured by PPP.

According to the Economist calculations, four currencies stand out as over-valued, Norwegian krone by 72%, Swiss franc by 68%, Danish krone by 55% and Swedish krona by 38%. The euro, which the IMF last week opined was as 0-15% over-valued, the Economists estimates at 29% over-valued.

Many currencies are regarded as under-valued. but these are all in the emerging market space. The Economists reckons that the Hong Dollar is the most under-valued (-52%), followed closely by the Chinese yuan (-49%). The Thai baht (-47%), the Russian ruble, Indonesia rupiah (-43%) and Philippine peso (-42%) are also regarded as extremely under-valued. Often, because of generally speaking higher inflation in developing countries, emerging market currencies tend to be under-valued.

In some ways the challenge is similar to what some equity fund managers are concerned about. With so many stocks trading above their 200 day moving average (some 80%), some fund managers struggle to find new mean reversion (value) plays. Similarly in the currencies, many of the majors are statistically speaking close to fair value (PPP). Because of the shifting prospects for growth, we would not be inclined to fade the Scandi bloc strength now, but the Swiss franc, which is over-valued and, not only is the SNB intervening to sell the franc as part of their quantitative easing strategy, and suspect the SNB will lag behind other central banks in raising rates. While it may be a little early to fight the dollar weakness, using the Swiss franc as the short-leg of crosses or as a financing currency may have merit.
Valuation In FX Valuation In FX Reviewed by Marc Chandler on August 03, 2009 Rating: 5
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