The Australian dollar is not overvalued.
That’s the inescapable conclusion of the NAB’s currency strategy team after they recalibrated their fair value model for the AUDUSD exchange rate recently to take account of key drivers of the Aussie dollar’s value.
In a new report released yesterday Ray Attrill, the NAB’s co-head of global currency strategy, said the recent “persistent overvaluation” of the model since the middle of the year had caused the bank to take a fresh look at the drivers of Aussie value.
The key change the NAB has made is the introduction of a specific NAB Australian commodities index (which replicates Australian exports) as an input into the model in place of the London Metals Exchange index they had been using previously. This has the impact of materially improving the fit with movements in the Aussie dollar.
Additionally Attrill said that the NAB changed the interest rate measure they were using and “have replaced the 1y Swap rate with the 1 year OIS rate and for the US we have recalibrated the US Shadow Rates so that historically it still reflects the impact unconventional Fed policy, but post the December 2015 Fed funds rate hike it reflects moves in 1y US OIS rates.”
The result is a model after the recalibration which has both a better fit and less standard deviation between the AUDUSD and the coincident fair value measure the NAB no generates.
“The result of this exercise is a fair value model with significantly improved characteristics (e.g. R2 of 0.958 versus 0.932) and with a materially smaller standard error (meaning that our fair value range around the model point estimate is now +/- 2 cents down from +/- 3 cents previously),” Attrill said.
The NAB says that whereas fair value under the old model was 0.7350, under its new model that level has moved up to 77 cents.
But Attrill suggests this does not now mean the Aussie is undervalued. Rather, he says, “this is not statistically significant and in fact, the AUD has consistently traded inside the new models’ fair value range since mid-2016”.
“In our view the AUD/USD is currently doing what it should. While a repricing of Fed expectations has been a downward force for the AUD, the pickup in commodity prices along with a relatively benign risk sentiment have more than outweighed this negative force,” Attrill said.
If markets get spooked further by the chance of a Trump presidency that may all change. But for now, based on the NAB’s analysis, the Australian dollar is not overvalued in the way that many traders and investors believe.