In the past few months, the strong deceleration in the Chinese economic activity combined with the sharp contraction in ‘liquidity’ (Total Social Financing 12M Sum YoY change) have been weighing on the Aussie against major crosses. After peaking at 0.80 in February against the USD, the Aussie has been constantly testing new lows and is now down nearly 10% against the greenback.
AUD is now the most undervalued (-15%) currency among the G10 world according to our BEER model, which uses terms of trade, inflation and 10Y interest rate differentials as explanatory variables to compute the ‘fair’ value of currencies.
The second most undervalued currency is ‘risk-on’ GBP, standing at -13.2% from its ‘fair’ value. The rise in volatility combined with the deceleration in global liquidity have been weighing on Sterling in recent months.
On the other hand, the CHF is the most overvalued currencies against the USD (+7.7%) according to our BEER model, followed by the EUR (+3.8%). It is interesting to see that the Euro, which appears significantly undervalued from a PPP approach (PPP estimates the ‘fair’ value of EURUSD at 1.41 – implying that the EUR is over 18% undervalued), is now overvalued using a BEER approach.
The chart below shows a quick analysis of EURUSD and VIX Index over the past six months. As you can see, the 20-day correlation between the two underlying assets has switched from a negative 80 in Mid-March to a positive 80.6% today. If you are a global macro trader, I personally believe that it is important to notice those changes between different asset classes, so you can see how a particular currency will react in case of a volatile day.
During the ‘Black Monday’ session this year (August 24th), the VIX Index soared above 40 and one of the surprising assets rallying was the Euro. On that day, EURUSD surged above the 1.17 level, up 350 pips in a few hours. Sell-side research started to call it the New Safe-Haven Currency, therefore reviewing its 3-month and 6-month to the upside.
Keep a small long EURUSD in your book ahead of the FOMC
In my opinion, I think it could be good to keep a long position on EURUSD ahead of the FOMC meeting this evening in case we see a bit of volatility.
Based on the macro situation in the US, a persistent moderate nominal growth and a poor core PCE deflator at 1% (Bloomberg PCE MBXYH Index), I think a no-hike scenario will make more sense. However, a 25bps is still in the game and wouldn’t have dramatic consequences for the market; but in that case, we could see a bit of equity sell-off, a higher VIX and therefore a higher EURUSD. An interesting level on the upside will be 1.1380; a break out could potentially bring EURUSD to 1.1450. On the downside, 1.1220 is the key level where I should potentially keep a safe stop.