A bit of EU/UK trade deal hope, UK data that showed the labour market improving in October and getting worse again in November. Solid Chinese data (as usual) and US industrial production and TIC data later. Not a lot to get the pulse racing, so I have been playing with G10FX valuation.
◼The simplest measure of FX valuation is purchasing power parity,using measures like theBig Mac index, which I don’t spend much time on because I don’t actually like burgers. I’ve published Starbucks PPP indices in the past, which were fun but have not been updated at all this year because the vast majority of my coffee has been made at home (even when I’m working in CanaryWharf, the coffee shop on the way to our office doesn’t open before the morning meeting so I need to bring a flask in with me). My favourite measure is the OECD’s, and is worth putting in a chart because it was that fine organization’s 60thbirthday yesterday. My father joined them when I was three and they had wonderful Christmas parties for the children of staff, earning my lifelong support as a result. On their measure, the most undervalued G10 currency is the euro, and the most overvalued is the Swiss franc. This hints at the fact that PPP isn’t a great trading tool, if nothing else! But it’s prima facie evidence that the euro, even at these levels, isn’t TOO expensive.
◼Another way to look at valuations is relative to where they have traded in the past. Here, wewant to look at realexchangerates, adjusting for inflation.To do that, I’ve used BIS real effectiveexchange rates, which run since January 1994. That’s an arbitrary starting point, and if aneconomy sees major changes over a long period, it can justify a big change in its real FX rate,butit’s reasonable way to look at it all the same. On average, the G10 currencies are 5%weaker today than over the average of the last 26 years. That’s partly because the Chinese yuan has almost doubled in value over that period, and partly becausethe US dollar is over 5% above its long-term average.So, the chart suggests that the dollar, 6% above its long-term average, is 11% stronger than the averageG10 currency. The swiss franc remains crazily expensive, but the current PPP overvaluation of NOK and SEK is actually lower than the average of the last 26years. As for the euro, on this measure too, it’s undervalued, although not as dramatically.
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David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
