Global Tactical Asset Allocation Q4 Update: Currencies
Courtesy of Damien Cleusix.
Please find attached the forex section of the Q4 GTAA Presentation.
The USD is becoming increasingly undervalued against most currencies. Its economy is much more dynamic and has started to rebalance earlier than elsewhere. Companies have been cutting costs aggressively and are much more competitive in the international markets.
The one big problem remains that the Fed is suppressing government bond yields through quantitative easing. Ceteris paribus, the USD will have to be more undervalued on a PPP basis to be in equilibrium. Indeed, the deficit of interests payment foreigners are receiving has to be compensated by a lower price I.e. lower USD (this is also one of the reason why emerging markets with negative real yields have very undervalued currencies on a PPP basis).
The declining USD is pushing other Central Banks/Treasuries to become increasingly aggressive buyer of USD to weaken their own currencies. They the have to recycle their newly acquired USD and in so doing are exerting a downward pressure on real rates in the US and thus weakening the USD. This can not last forever. This will end by a radical redisign of our current monetary system and the sooner the better. The winner… Gold.
Sentiment is mixed to supportive for the USD. Speculators seems to have been accumulating a sizeable short position on the USD around the world (except in Japan where “housewives” are very long the USD, for now) but we are not seeing inflows into the Rydex short USD funds and online forex punters are still net long USD.
There is a big global short USD position which is growing by the day as the increase in foreign central bank reserves can not be completely explained by their current account balance and the net foreign direct investments. We are on the look out for canaries…
The Euro remains approximately 7-10% overvalued, after its recent rebound. We are still forecasting below parity sometimes (around 0.7 to be precise). The EFSF got the expected AAA (Aaa) rating and this might give a false sense of security to punters (funny to see that Moody’s noted that one of the identified risk was the “willingness” of the backers to actually back if support was needed).
Sentiment is neutral with speculators still having a small net short position and the risk reversal in synch with the price up trend (even leading to the upside). Remember that during a trend, it is not rare for sentiment to stay on one side for prolonged period. The strategy is to cover some short when sentiment is extreme and re-enter those short when sentiment improve sufficiently, even if it is still only neutral.
The trend is up and we are in the middle of an important resistance zone (1.31-35). A break above this area could imply a move toward 1.375-1.39 (even 1.415). We would be seller on such a move on the slight break in the short-term up trend. Alternatively we would short a move below 1.30.
The Yen overvalued by at least 20%. And the authorities have now started to intervene putting an implicit floor below the current levels (the Yen could fall to 79.5-80 but not much lower).
There is a big non-commercial net long position which is diverging with price (net long position not increasing on Yen strength). The divergence is also visible on the risk reversal. “Housewives” have a big net short position against the USD, the AUD and most other currencies.
There are/have been big inflows of hot money in the past couple of months with the Yen rising despite the broad balance of payment registering a deficit of more than 8% of GDP.
The trend is down but there is now an implicit floor. The Yen rebounded to the top of its declining channel where it is consolidating. We would sell puts on the cross on weakness and would probably start to build a new short Yen position on a move below 0.84 or on a move above the recent highs (86).
The British Pound remains slightly undervalued but deserve to trade at a bigger discount. Many accidents are just waiting to happen with notably the residential real estate market. Authorities will use, among others, a depreciation of the Pound to support the British economy.
Speculators have a small net short position while the risk reversal is still in synch with the cross. Online traders are net short but their net position has fluctuated widely in the past few weeks.
The medium-term trend is up as long as 1.545 holds.
The CHF is overvalued and the SNB has been clear in its desire to see the currency depreciate. Its main problems is that it has already intervened massively and is running out of options. Walls of money are still heading to Switzerland from European banks while many holders CHF-denominated mortgage in Eastern Europe are slowly but surely getting squeezed.
Speculators have a big net CHF long position but we are seeing a divergence (CHF rising while net long position not increasing). The same divergence is visible on the risk reversal. This is the only cross along with the Yen which is having those divergences.
The trend is down and extended. We would sell 1-3% OTM puts on the cross at current levels (.985) and get outright short the CHF on a break of the down trend (would require a move above 1.02 currently).
Commodities currencies are overvalued… The AUD is probably more than 30% above fair value while the NZD is approximately 10% overvalued. The CAD is more than 5% overvalued.
They have profited from the "Chinese inventory build-up" related commodity rally but the momentum seems to be fading and we are not bullish on commodities going forward. Furthermore, the Royal Bank of Australia and its New-Zealand counterpart have clearly expressed concern about their currency overvaluation.
Speculators have again accumulated big net long position on the AUD and NZD while they are only slightly long the CAD.
The AUD is entering into a significant resistance area and is approaching the top of its rising medium-term channel (.965). We are seller (as is the RBA…) on a move toward .975-.985. or on a move below .9065.
On emerging currencies, we prefer to stay on the sidelines for now as valuation are not attractive and authorities seems to have decided, especially in Latin America, that their currency should depreciate. If we had to we would maintain a long position on the Taiwan Dollar, the Korean Won and the Singapore Dollar. The more then Yen decline the less attractive the Won proposition will become…We would not short, however, as the carry is too high for most of them.