FX Valuations – AUD Increasingly Expensive, TWD at Odds With US View

Dollar weakness through April reversed what was a difficult Q1 for most currencies. In G10, CHF, SEK and NOK all had a strong month on a combination of recent upgrades to global growth expectations, EUR strength and higher commodities. CAD strength also continued buoyed by BoC taper talk while the UK’s rapid vaccine rollout and gradual reopening has benefitted GBP.

In EM, currencies have rallied across the board over the past month the most risk sensitive currencies such as BRL and ZAR recording fairly large gains. CE3 FX is also up with a stronger EUR (the euro has retraced back to 1.20 after hitting a low of 1.17 in February). INR and JPY have been outliers with both economies under pressure from a surge in COVID cases. For FX valuations, NZD and TWD remain significantly overvalued while TRY undervaluation has become even more extreme with the latest CBRT reshuffle and prospect of rate cuts. SEK undervaluation eased back from the highs in march. (We prefer to look at PPP and real trade weighted based valuation metrics as they have tended to be more reliable than BEER and FEER models).

In G10

• SEK, NOK, GBP and JPY remain the most undervalued currencies. GBP still looks attractive with the economy re-opening and vaccine rollout remaining strong. For the others, SEK undervaluation should narrow as the currency benefits from the global upswing. For JPY, high oil prices and the ongoing COVID crisis will keep the yen undervalued. The reverse is true for NOK. (Chart 1,3).
• NZD remains the most expensive currency, and not much changed from a few months ago, while AUD has overtaken CHF to become the second most expensive in G10. It is notable that in contrast to Europe or Japan both these economies have re-opened with COVID firmly under control. This suggests that undervaluation in AUD or NZD is unlikely to reverse anytime soon. (Chart 4).
• EUR/USD continues to trade around fair value (1.20, Chart 2) after moderate weakness earlier in the year.

In EM

• On a trade-weighted basis, TRY, BRL and RUB remain at undervaluation extremes, but only TRY looks even cheaper than versus December. Lira undervaluation has been the largest in EM for some time but at 35% this is now this is around 10pp larger than for BRL and 15pp for RUB (Chart 5). And with Brazil and Russia committed to further rate hikes and Turkey likely to start lowering its policy rate the lira could yet become even more undervalued. Earlier mean reversion of BRL and RUB also leaves these currencies as attractive value plays (Chart 6,7).
• On the expensive side, TWD continues to stand out as the most overvalued currency at close to 20%. This overvaluation is in contrast to the US Treasury view that the currency is ‘structurally undervalued’. The research note quoted by the Treasury refers to a 2018 estimate. USD/TWD was 30.9 at the time (versus below 28.0 this week) and the quoted FEER consistent rate at 25.5.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

Caroline Grady is Head of Emerging Markets Research at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)