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The Outlook for Currencies


The euro remains the worst G7 currency to hold on a valuation and macro-risk basis.

Editor's Note: This article was written by Damien Cleusix (damien (at) It is the second part in a five-part series on Global Tactical Asset Allocation. To read the first part, click here; the third part, click here; the fourth part, click here; and the fifth part, click here.

Valuations -- Developed

Valuations aren't very helpful for short-term forecasts but are essentials to put the short, medium, and long-term trends into perspective.

The Euro (Chart 1) is now hovering near the over 20% overvaluation against the USD. In September I said: "We will use any trend deterioration to increase our short small position further… It is not a question of if but when… ." Well, the trend has now deteriorated (more on this later).

The British Pound (Chart 2) is at fair value after having been more than 15% below fair value around March. I expect the currency to undershoot its fair value by more than 20% before it could embark into a new real appreciation course.

The Japanese Yen (Chart 3) is approximately 15% overvalued and in this environment, I'd say that 20% is the extreme limit (was there a couple of weeks ago).

The Swiss Franc (Chart 4) is overvalued, as always, but has now reached a level of overvaluation where the currency has struggled in the past.

The Canadian Dollar (Chart 5) is slightly overvalued (more than that if we look at the historic valuation range), while the NZD (Chart 7) is in a danger zone being more than 20% overvalued.

The AUD (Chart 8) is now more than 30% overvalued and is an accident waiting to happen. There are many reasons for its strength (strong economy, links to China, etc.) but too much is too much.

Furthermore, Australia is showing the same kind of excess (I'd say even more) on the credit and housing side as the US and the UK…Well, timing the day of reckoning is impossible but the day will come. Keep an attentive eye on it.

Looking at valuations for Emerging Markets can be deceptive.

Using PPP, FEER, BEER, and other models, most seem to be chronically undervalued.

In 1964, Balassa and Samuelson presented an economic model (today known as the Balassa-Samuelson effect) to explain the "Penn effect."

The "Penn effect" was the observation that price levels where systematically higher in richer countries compared to poorer one.

Balassa and Samuelson demonstrated productivity in tradable goods, and as a consequence wages are lower in poorer countries. As a result, the relative price of non-tradable to tradable goods and services increase in richer countries. This lowers the PPP.

Valuations -- Emerging

In Chart 8 I've regressed the PPP implied over/undervaluation with the GDP per capita (at PPP). The expected strong relation is apparent.

I then compared the PPP over/undervaluation with the over/undervaluation obtained by regressing the GDP per capita (Tables 1, 2, and 3).

South-East Asian currencies (Table 1) have continued their move toward slightly overvalued levels. The Singapore Dollar (even if the currency is used actively by the monetary authorities) and the South Korean Won remain our favorite local currencies based on those metrics.

South American currencies (Table 2) should be avoided based on those metrics.

Eastern European currencies (Table 3) where identified as highly undervalued back in January-March 2009 and are now back to fair value which isn't justified given the potential risks lying ahead.

I exited the long Ruble position back in September and would continue to stay away for now. South Africa and Turkey have now moved back to overvaluation.
No positions in stocks mentioned.

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