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Like uncomfortable teenagers, markets love “normal” and rail at the different or quirky. But investors must be consistent: if the good old days have really returned to everything from stock prices to bonuses, then exchange rates should be looked at in traditional ways too.
That means goodbye to wailing speculation about the death of the dollar in favour of currencies that few investors can even spell. What then do the tried-and-tested metrics say? Currency movements are notoriously tricky to forecast, but Deutsche Bank focuses on three indictors that all suggest the weakness in the dollar since March is overdone. On a trade-weighted basis, versus historical trading bands, the dollar is 12 per cent below “fair value”. It is even more undervalued against the euro and commodity currencies such as the Australian dollar.
The dollar also tends to move with changes in the sum of the US current account deficit plus portfolio flows (roughly the supply and demand for dollars on international capital markets). By this measure the dollar is slightly cheap. It is also undervalued when comparing interest rate differentials, especially if America is first to emerge from recession and yields on 10-year Treasuries march higher.
Of course, plenty of things move currencies in the short-term. During the past three months, the dollar’s changes against the euro, for example, have moved most closely with the oil price – a higher oil price worsens the current account deficit and is, therefore, bad for the dollar; or risk indictors such as the CBOE’s Vix index – because traders flock to the dollar whenever there is a peep of bad economic news. Still, the dollar now looks a good bet. Those in the “normal’ camp can buy it on fundamental grounds, while the hell-in-a-handcart crew knows it’s a safety play.
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