Like many other risk assets, emerging market currencies have performed strongly in 2016, recovering some of the ground lost in the preceding three years.
After the recent move, coming at a time when global growth remains tepid at best, many are now asking themselves whether they are no longer cheap.
To HSBC’s emerging markets FX research team, led by Paul Mackel, the answer to that question is no, not yet. To HSBC, they’re either fairly valued or undervalued right now against the US dollar. Or, put another way, the US dollar is still broadly overvalued.
The table below shows HSBC’s “Little Mac Valuation Ranges”, a measure created by the bank to determine current FX valuations.
It is colour coded: green for undervaluation, red for overvaluation, and white when there is no clear valuation signal. The first and fourth columns show the HSBC’s Little Mac Valuation Ranges in January and August, respectively.
Even with the rally seen since the start of this year, there’s a lot of green, indicating that there’s still a lot of undervaluation based on this one metric.
While HSBC suggests that valuation alone is usually not a strong enough reason to buy or sell a currency, it says that it’s “certainly an important factor in the overall assessment”.
“Despite the rally year-to-date by EM currencies, we see little sign that they are overvalued against the USD at this point,” it says.
“That, in conjunction with HSBC’s view that G3 monetary policies will stay accommodative and the global economy remains on track for a gradual recovery, supports our long-held thinking that the worst has already passed for EM currencies.”
HSBC currently favours higher yielding currencies with positive domestic stories and undemanding valuations, such as the Indonesian rupiah and the Indian rupee.
It also suggests that low-yielding currencies with large current account surpluses – the South Korean won, the Thai Bhat, the Israeli shekel, and the Hungarian forint “are likely to stay relatively strong and help share the burden of effective appreciation with the reserve currencies”.