Best Currency Positions For March 2017

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Includes: CROC, DBV, DRR, ERO, EUFX, EUO, FXA, FXB, FXC, FXE, FXF, FXS, FXSG, FXY, GBB, ICI, JYN, UDN, ULE, URR, USDU, UUP, YCL, YCS
by: Ruerd Heeg

Summary

Here is a new list ranking currencies based on relative purchasing power. Overvalued and the least undervalued currencies are at the top. The most undervalued currencies are at the bottom.

This list is combined with a list of currencies ranked on differences in interest rate with the US. Based on these numbers, I discuss some carry trades.

Finally, I will discuss developments and opinions for a number of currencies with relative purchasing power in mind.

This is an update of my article from last month. See also the first article in this sequence. In that article, I value currencies based on changes in purchasing power relative to changes in purchasing power of other currencies. There, I explain this concept further.

Changes in 5-year inflation and exchange rates result in a new ranking. See the table below.

Rank (change)

Currency

Price

(per USD)

Jan. 23, 2017

Last month's

result

Price

(per USD)

Feb. 24, 2017

Current

Result

1

HKD ↓

7.757

-0.093

7.760

-0.151

2

KRW ↑

1168

0.040

1131

0.013

3

NZD ↑

1.391

0.142

1.383

0.132

4

SGD ↑

1.420

0.146

1.405

0.136

5

CHF ↓

1.000

0.155

1.007

0.145

6

EUR ↓

0.9315

0.250

0.9459

0.256

7

GBP ↑

0.8031

0.261

0.7981

0.257

8

DKK ↓

6.930

0.262

7.031

0.269

9

PLN =

4.075

0.306

4.075

0.290

10 (-1)

CAD ↑

1.330

0.324

1.310

0.306

11 (-1)

AUD ↑

1.328

0.340

1.298

0.308

12 (+2)

HUF ↓

288.5

0.319

291.9

0.315

13 (-4)

MXN ↑

21.4

0.517

19.75

0.368

14 (+1)

SEK ↓

8.848

0.347

8.991

0.374

15

ZAR ↑

13.52

0.489

12.96

0.398

16 (+2)

NOK ↑

8.393

0.405

8.342

0.409

17 (+1)

JPY ↑

113.6

0.500

112.6

0.494

The higher the rank number, the more undervalued a currency is against the USD, at least on a statistical basis. For example, the Korean won, with ticker KRW, at place 2 is almost fairly valued compared to the USD. The Japanese yen, with ticker JPY, at place 17 is the most undervalued currency on a statistical basis. A negative value (e.g., the Hong Kong dollar, or HKD, at 1) in the column "Result" means the currency is overvalued compared to the USD.

A carry trade list

Another statistically favorable trade is being long in the currencies with high interest rates and short in currencies with low interest rates. These are also called carry trades. Investors with a carry trade position make money from the extra interest they get. Their risk is in the exchange rates. In practice, however, such a position is profitable on a statistical basis based on the exchange rates alone. So it is more likely the currency with the low interest rate goes down instead of going up against the currency with the high interest rates. The PowerShares DB G10 Currency Harvest ETF (NYSEARCA:DBV) uses this statistical principle.

I have also made a list ranking currencies on interest rate difference with the USD. Again, the higher the rank number, the more undervalued (or less overvalued) a currency is, based on the difference in interest rate with the USD. A negative difference means the currency is more likely to be overvalued, and a positive difference means the currency is more likely to be undervalued against the greenback. The problem I have with this theory is that the prices of the currencies are not in the comparison. Unlike with the ranking based on relative power purchasing parity, here the currency prices do not determine the ranking. Still, I made the comparison using the benchmark rates from Interactive Brokers:

Rank

Currency

Price

(per USD)

Feb. 24, 2017

Δ %

1

CHF

1.007

-1.459

2

SEK

8.991

-1.205

3

DKK

7.031

-1.105

4

EUR

0.9459

-1.014

5

JPY

112.6

-0.675

6

HKD

7.760

-0.587

7

HUF

291.9

-0.520

8

GBP

0.7981

-0.436

9

SGD

1.405

-0.287

10

CAD

1.310

-0.160

11

NOK

8.342

-0.160

12

KRW

1131

0.59

13

AUD

1.298

0.84

14

PLN

4.075

0.970

15

NZD

1.383

1.090

16

MXN

19.75

5.935

17

ZAR

12.96

6.311

If we combine these strategies by adding the ranks of each strategy, we get the following list:

Rank

Currency

Price

(per USD)

Feb. 24, 2017

Rank RPPP

+

Rank Δ %

1

HKD

7.760

7

2

CHF

1.007

7

3

EUR

0.9459

11

4

DKK

7.031

12

5

USD

1

14

6

SGD

1.405

14

7

KRW

1131

16

8

GBP

0.7981

16

9

SEK

8.991

17

10

NZD

1.383

20

11

HUF

291.9

20

12

CAD

1.310

21

13

JPY

112.6

23

14

PLN

4.075

25

15

AUD

1.298

26

16

NOK

8.342

28

17

MXN

19.75

31

18

ZAR

12.96

34

Carry trades with favorable purchasing power properties

According to these 3 tables, a good carry trade would be to short the CHF and go long the ZAR. Not only does this trade exploit a large interest rate difference of 7.77%, but it also is a good bet based on purchasing power parity. Another possibility is shorting the CHF against the MXN with an interest rate difference of 7.394%. Good carry trades not involving currencies of less developed countries are shorting CHF against the AUD (2.299%) or the NOK (1.619%). When going long the AUD, of course, the HKD could be shorted as well instead of the CHF. In that case, the bet is on de-pegging followed by depreciation of the HKD with an interest rate difference of 1.427%.

Discussion

Most currencies went up against the US dollar in the absence of major news. For the euro, the French presidential election will be important. If Marine Le Pen is elected, France may leave the euro. That could destroy confidence in the currency. At the moment, there is still no good alternative candidate for Le Pen on the right side. Also, the left side is not (yet) united. That the deadline for refinancing of certain Greek bonds is getting closer also increases pressure on the euro.

Trump has been talking the yen up. He has accused Japan of currency manipulation. Based on relative purchasing power, he has a point. Japan claims not to have intervened in its currency for many years, but the money printing suppresses JPY exchange rates. I still think the growing government debt is not sustainable. It more or less makes the money printing mandatory. That will eventually lead to a sharply increasing inflation and a lower yen.

Investors expected Trump would have announced his tax plan by now, but that has not happened yet. This plan would allow American companies to repatriate profits from foreign or Asian subsidiaries. When companies repatriate accumulated profits, their money will be exchanged for the greenback. US Treasury Secretary Steven Mnuchin, however, just said the reform will be "done" in August. That no such plans have been announced yet puts pressure on the USD. Of differently said, this has caused the yen and possibly also the South Korean won to move up, at least in the short term.

As my comparisons show, Hong Kong has experienced more inflation than the US, and yet, it has kept its currency pegged to the USD. In the past, traders have been trying to short the HKD against the USD. Their hope was Hong Kong would remove the peg, after which the HKD would depreciate. So far, they've failed. The peg is already 32 years in place and had survived the Asian crisis in 1997, the dotcom crisis in 2001 and the financial crisis in 2008. This excellent article describes how and why this could change. See also this subsequent article on the timing of de-pegging.

In short, Hong Kong has experienced more inflation than the US between 1990 and 2003, despite deflation from 1997 to 2003. This is possible because of capital outflows from the PRC to Hong Kong. De-pegging may be inevitable, but does not need to imply a depreciation of the HKD. Instead, capital outflows from the PRC could (temporarily) push the HKD higher.

The AUD continues its rally. Macro Investing writes this is not sustainable. He/she thinks a decrease in iron ore prices and an interest rate hike in the US will weaken the AUD. Based on purchasing power and on the current positive interest rate difference, a bet to a weakening AUD has a negative expectation value. Even though the AUD went up during the last 2 months, its rank based on relative purchasing power is still the same as in December 2016.

The Mexican peso has rallied even more than the AUD. The Trump effect is definitely fading. I don't think he will have that wall built. Furthermore, people accuse him of things worse than Watergate. Why would someone of his team meet the Russian secret service during the campaign? Why would this Trump team member discuss the sanctions without getting anything in return? These speculations are good for the peso. I expect them to continue and evidence to be produced.

Furthermore, at the end of November 2016, oil went up. This is important, since Mexico is a net oil exporter. Until a month ago, this did not result in the peso moving up. In August 2016, the Mexican government hedged when the price is much lower. This hedge might be the reason we are only now seeing the effect of the increased oil price on the peso. Finally, last week's run-up was triggered by the announcement of an intervention from the Mexican central bank.

Above, I suggested the Swiss franc as the short leg of a pair trade. This is a contrarian opinion - see here. There are people who think instability of the EUR (France elections, rise of anti-EU parties in Germany and Netherlands, Brexit) could add to the strength of the CHF. In the meantime, as the linked article acknowledges, the Swiss National Bank is doing everything it can to keep the CHF low. Can it do even more?

I must agree: probably not. The interest rate is already much in the red. Can the bank buy more assets for new francs? It is running risks on its reserves: ultra-low interest rate bonds and equities. All these instruments are held during an all-time high. In the meantime, some unfavorable events have not (yet) happened: for example, the election of Le Pen in France, and problems with financing Greece. Another unfavorable event is more or less certain to happen, such as the Brexit. So this event should be priced in already. If the unfavorable events don't happen, I expect a reversal based on both the interest rate difference and relative power purchasing parity.

The Norwegian krone went up, but it still moved down two places on the relative purchasing power list. So it was more undervalued compared to the other currencies. See this article and this one. The Norwegian central bank has put the interest rate on hold since August 2016. As a result, the Norwegian krone will gain on rising oil prices. Since August 2016, oil prices have increased by about 20%. The Norwegian krone will suffer if interest rates go up in the US or elsewhere. This is likely, but has not happened yet. Furthermore, relative purchasing power indicates these interest rate increases and a decrease in the oil price have been priced in already.

The Hungarian forint went down. It went also 2 places down on the relative purchasing power list. So it got more undervalued compared to the other currencies. The German Commerzbank sees a 3.7% higher HUF in terms of the EUR: from 308.5 HUF per EUR now to 320 by year end. The bank thinks inflation will be lower than the central bank expects. That would allow the central bank to continue its expansive monetary policy. Even if interest rates rise elsewhere, Hungary's current account surplus will "stave off some downward pressure."

And did you wonder why the South African rand went up? It was all rigged! Citibank and other banks settled.

No, Dr. Gautam Kalani from Deutsche Bank thinks the South African economy will recover. That will be the trigger for a further rise of the rand. He thinks the rand is still 8% undervalued based on the current trade balance. He also thinks the South Africa's trade balance will show larger surpluses in future.

Relevant ETFs and ETNs:

  1. PowerShares DB USD Bull ETF (NYSEARCA:UUP)
  2. ProShares UltraShort Euro ETF (NYSEARCA:EUO)
  3. CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB)
  4. ProShares UltraShort Yen ETF (NYSEARCA:YCS)
  5. CurrencyShares Euro Trust ETF (NYSEARCA:FXE)
  6. WisdomTree Bloomberg U.S. Dollar Bullish ETF (NYSEARCA:USDU)
  7. CurrencyShares Canadian Dollar Trust ETF (NYSEARCA:FXC)
  8. CurrencyShares Australian Dollar Trust ETF (NYSEARCA:FXA)
  9. CurrencyShares Swiss Franc Trust ETF (NYSEARCA:FXF)
  10. PowerShares DB G10 Currency Harvest ETF
  11. CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY)
  12. Market Vectors Double Short Euro ETN (NYSEARCA:DRR)
  13. PowerShares DB USD Bear ETF (NYSEARCA:UDN)
  14. Guggenheim CurrencyShares Swedish Krona Trust ETF (NYSEARCA:FXS)
  15. ProShares UltraShort Australian Dollar ETF (NYSEARCA:CROC)
  16. ProShares Short Euro ETF (NYSEARCA:EUFX)
  17. ProShares Ultra Euro ETF (NYSEARCA:ULE)
  18. ProShares Ultra Yen ETF (NYSEARCA:YCL)
  19. iPath GBP/USD Exchange Rate ETN (NYSEARCA:GBB)
  20. CurrencyShares Singapore Dollar Trust ETF (NYSEARCA:FXSG)
  21. iPath EUR/USD Exchange Rate ETN (NYSEARCA:ERO)
  22. iPath Optimized Currency Carry ETN (NYSEARCA:ICI)
  23. Market Vectors Double Long Euro ETN (NYSEARCA:URR)
  24. iPath JPY/USD Exchange Rate ETN (NYSEARCA:JYN)

I do not recommend these products. I only include them such that this article can be syndicated along their ticker symbols.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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