This blog was published on 21/08/18 and does not constitute advice, nor should it be seen as a personal recommendation from Societe Generale. Information quoted within may be out of date at the time of your reading this blog.
One should remember that currency valuations are an uncertain territory full of mirages and pitfalls for the unwary traveller, but there are opportunities for sophisticated investors to capitalise on even small fluctuations in currency prices using leveraged ETP’s.
The dollar weakened against sterling earlier this year and then bounced back, going from strength to strength. From its lowest point this year, it’s risen 7% to recent highs. While there seems to be a general consensus that US equities are overvalued, where does this put the greenback?
Not only are there mounting trade tensions in the US and looming interest rate hikes weighing on the US dollar. The dollar is now the highest-yielding currency in the G10.
In fact, the dollar is up nearly 7% from its 2018 low in February, according to The Economist. The Economist’s Big Mac Index shows that the US dollar is at the moment overvalued against the euro by 16% and sterling by 30%. The only currencies currently valued higher are the Swedish Krona and the Swiss Franc.
The Economist explains that this is worked out by the value of a Big Mac. Currently, a Big Mac costs £3.19 in Britain and in the US it’s $5.51. “The implied exchange rate is 0.58. The difference between this and the actual exchange rate is 0.75, which suggests the British pound is 23.2% undervalued.” Albeit the downside to the Big Mac is that it is a relative luxury product in some countries and a cheap product in others, which affects local pricing. The Council on Foreign Relations (CFR) in the US has started compiling a Mac Mini index that it promotes (tongue suitably in cheek) as superior to The Economist’s Big Mac index.
Source: Bloomberg as of 14/08/18. The figures relating to past performances relate to past periods and are not a reliable indicator of future results.
Last month the International Monetary Fund also said that the dollar was overvalued. Reuters reported in July 2018 that IMF staff assessed the U.S. dollar again to be over-valued compared to levels implied by medium-term fundamentals, by about 8% to 16% last year.
The IMF stated in its report that: “Large and sustained excess external imbalances in the world’s key economies—amid policy actions detrimental to external balances—pose risks to global stability. The fiscal easing currently underway in the United States is leading to a tightening in monetary conditions, a stronger US dollar, and a larger US current account deficit.”
President Trump also recently complained that the Fed’s interest rate hikes were causing the dollar’s value to rise removing their competitive edge in exports.
As an example in May 2018, Investment Europe previously put out an article by Michalis Ditsas, fixed income investment specialist, and Fabrizio Quirighetti, co-head of multi-asset and manager of the OYSTER Absolute Return fund at SYZ Asset Management, who gave ten reasons why the dollar would weaken.
Another indicator as to how the dollar will perform is to look at the US Treasury 10 Year Yield. It’s currently trading at around 2.95. However, according to Jonathan Golub in May 2018, chief US equity strategist at Credit Suisse, if it goes above 3.5 then equity returns start to decline.
However, this could be bullish for the dollar. DXY dollar index is now at its highest level since July last year, according to data from Bloomberg.
Marvin Barth, head of FX Strategy at Barclays, told Bloomberg News last month that the dollar is not overvalued and could go higher.
“Even in the event of an escalation in the trade war, the US is "relatively more immune" than other economies presumably because it is not as reliant on exports and has a large domestic market, thus the dollar could be resilient versus counterparts, especially those that rely heavily on exports.
The Fed is also likely to have little impact on the dollar with it likely having already been priced in.
Ester Rechelt, FX strategist at Commerzbank, also told Bloomberg News in July 2018 that they can’t really expect much new of Jerome Powell, FED chairman. "I would be surprised if we get a further boost of the dollar. He has already said everything there is to say a week ago. He is very bullish on the economy...Obviously he sees risks from a trade war but that is not what the Fed is focusing on, and the Fed is clearly a positive factor for the dollar going forward."
Remember, as with most investments, the value can go down as well as up, and as a leveraged investment these products are designed for sophisticated investors, so if in doubt, seek advice.
Post by: Zak de Mariveles, Head of UK Exchange Traded Products
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