- ANZ has updated its currency valuation models.
- The Swiss franc is deemed to be the most overvalued currency with the Swedish krona the cheapest.
- The Australian dollar is among the most overvalued.
If you’re a long-term currency trader, or looking to make an investment overseas and wondering if you should hedge your currency exposure, the chart below from ANZ Bank may be of some interest to you.
It ranks current currency valuations against the US dollar using an average score from behavioural equilibrium exchange rate (BEER) and purchasing power parity (PPP) models created by ANZ.
Using nominal interest rate and inflation differentials, along with relative terms of trade and investment-to-GDP ratios for individual currencies, something ANZ says are thought to affect the exchange rate movements in the medium-to-long term, the BEER model aims to assess how misaligned each is currently from fair value.
“We prefer the BEER model valuation framework for long-term forecasting… [given it] has two relevant advantages,” says Daniel Been and Giulia Lavinia Specchia, members of ANZ’s FX strategy team.
“It is simple and it does not rely on assumptions that are hard or impossible to observe in reality, such as measuring the level of output at full employment, [and] it allows us to include variables available at higher frequencies such as interest rates, so we can adjust forecast equilibrium values more often. “
So what is the model saying right now in terms of current misalignment?
According to ANZ, it’s those currencies with central bank’s that are running the easiest monetary policy that are the most undervalued.
“Across the G10 currencies, the largest deviation from fair value is in the Nordic currencies — SEK/USD and NOK/USD — and in USD/JPY, all of which are significantly undervalued,” says Been and Specchia.
“We suspect the dovish central banks in these countries are the reasons why the exchange rates have consistently undershot their fair value levels.”
Cable, or GBP/USD, is also deemed to be undervalued, but ANZ warns that not too much weight should be placed on this assessment given uncertainty surrounding Brexit negotiations.
At the other end of the spectrum, the Swiss franc and Australian and New Zealand dollar’s are deemed to be the most overvalued currencies right now, although Been and Specchia say their deviation is not extreme and remain within historic norms.
For the Euro and US dollar index, both are deemed to be around fair value at present, with the Canadian dollar also fast approaching the models perceived equilibrium level.
ANZ will now use its BEER and PPP modelling as the main point of reference when determining its long-term currency forecasts.
“Our forecasts are constructed using the combination of the signals from the two models and their typical mean-reversion path,” Been and Specchia says.
“That said, we intend to complement our short-to-medium term FX views with the evaluation of a number of fundamental drivers and technical tools and models — including short-term fair value models — that we have developed to gauge the likely direction of currency moves at different time frequencies.”
Here are the ANZ’s current forecasts.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.