ANZ reckons the Australian dollar is overvalued by 10%

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On the back of renewed strength in commodity prices and reduced expectations for the US rate hikes in the year head, the Australian dollar has been resilient of late.

After plumbing a fresh six-year low of .6824 on January 15, the Aussie has rallied by nearly 6% over the past six weeks, leaving it trading at .7228 against the US dollar, near the highest level seen this year.

Richard Yetsenga, global head of financial markets research at ANZ, is one analyst who has been been surprised by the recent strength in the Aussie, suggesting that based on the bank’s modelling, it is currently overvalued by the most seen since 2012.

The chart below, supplied by ANZ, tracks the “valuation gap” between the long-term average for the Australian dollar (as well as its New Zealand counterpart) in real effective exchange rate terms (REER) relative to the US dollar’s current position to its long-term average.

A REER is simply a trade-weighted average of a currency compared to a basket of other major currencies, adjusted for inflation.

“When the USD is strong, other currencies should be weak,” says Yetsenga. “When the indicator is rising in a strong USD environment (as it has been), it implies that the focus currencies have not been falling to offset the rise in the USD.”

Yetsenga suggests that based on their modelling, the Aussie is currently overvalued by 9.6%, just slightly below the 11.6% overvaluation in the Kiwi.

“Apart from the height of the reserve diversification thematic in 2012, the AUD is essentially as overvalued as it has ever been,” says Yetsenga.

While he believes that the decline in the Aussie is now “quite mature”, Yetsenga suggests there are grounds for further weakness in the period ahead.

“While it is difficult to see the immediate catalyst for an imminent decline in either the AUD or NZD, and it is certainly true that the multi-year declines in AUD and NZD appear to be quite mature, these sorts of metrics suggest there is still further downside from current levels in trade weighted terms before the current deprecation cycle completes,” says Yetsenga.

He also believes that the recent rally in the currency in the spot iron ore price has taken it “further away from any reasonable calibration to fair value”.

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