When Do the Euro and Pound Become Value Plays?

Since the middle of July, a little less than 2 months ago, the Euro has lost approximately 1900 pips or close to 12 percent of its value against the US dollar. As the currency continues to slide and comes within a whisker of our 1.40 target, the next question on everyone’s mind is when does the Euro become a value play?

Here is a snippet from my Daily Currency Focus.

Based upon Economist Magazine’s Big Mac Index, which is a rough calculation of purchasing power parity, the Euro does not hit fair value until parity, which is one to one with the US dollar. The OECD has a much more comprehensible valuation for the Euro. According to their latest report and the estimates of many economists, the EUR/USD is fairly value at 1.10 to 1.20. Purchasing parity has its flaws because it only compares the price of a specific good or basket of goods and it does not take into consideration the quality of the goods. Nonetheless, understanding what the PPP value of the EUR/USD is allows us to understand how much further the EUR/USD can fall.

Like the EUR/USD, the GBP/USD does not become fairly valued until 1.65. Of course, purchasing power parity has mattered little to the Euro or the British pound over the past few years when both currencies have seen impressive rallies against the US dollar, but at this juncture, it provides us with reference for fundamental support. Technically, 1.75 is decent support, but below that level, more meaningful support comes in at 1.70.