Fair Value is a nebulous concept when it comes to FX rates.
We have purchasing power parity which is essentially useless in the real world, we have the Big MAC index which is intuitively more appealing but still more fun than real, and then we have a myriad of different valuation or “fair value” models for individual currency pairs built by many different market participants.
When it comes to the Australian Dollar, it is the NAB Fair Value model and the work of the NAB’s co-Head of Currency Strategy, Ray Attrill, that I have the most time for.
They have recently updated their model to take into account the impact of QE which is incredibly insightful and difficult, but I always loved the original model which is build on an equation that takes into account:
- Weekly 2-year swap spread
- Industrial Metals prices
- NAB’s risk appetite index and
- Gold prices
At present the combination of these drivers of the Aussie dollar gives a “fair value” of 0.9360 against a spot price presently of 0.9230. The chart is below and you can see the standard deviation range as well, which gives the Aussie a lot of room to rally and still be within the “fair value range”.
Speaking to BI Australia yesterday, Attrill said:
I think the recent disconnect between AUD and FV estimates is being driven by the contagion effects from the EM sell-off onto AUD and NZD, but which is not being adequately captured in the VIX, which is our risk appetite proxy.
That makes sense, but as we highlighted yesterday, China and EM data flow is turning more positive and the Aussie just might be lagging.
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