USD Increasingly Overvalued But EUR/USD Still Set To Test

USD Increasingly Overvalued But EUR/USD Still Set To Test

The US dollar enjoyed quite a ride following the hawkish hike. What’s next? Here is the view from ANZ:

Here is their view, courtesy of eFXnews:

How far and how long the dollar’s appreciation will continue is increasingly coming into focus.

From a valuation perspective, the dollar is becoming increasingly overvalued.  Based on relative producer prices and the Big Mac framework, PPP estimates suggest it is about 20% overvalued vs the euro and 25% overvalued against sterling. It is 15% stronger than its long run average exchange rate against the euro since 1999, and 25% below its long run average against GBP over the same time frame.

Currencies can deviate from equilibrium values for prolonged periods of time  and it will be interesting to see if there is a more activist exchange rate policy under a Trump administration, who made significant references during the election campaign to the size of the US goods trade deficit (c USD750bn pa) and the loss of jobs abroad – particularly in manufacturing. He indicated a strong rise in the USD was not optimal and that the US needed to be competitive. It is quite plausible that once in office, both the level and rate of appreciation in the exchange rate may become more of a focus for his administration. The exchange rate policy will be closely scrutinised.

For now though, in an open economy with perfect capital mobility, an expansionary fiscal stance should raise demand and growth. Currently, expectations of that are leading to an appreciation in the exchange rate. So far the FOMC has not upgraded its growth forecasts and inflation forecasts and therefore has not augmented its interest rate forecasts bar a 25bps tweak to next year’s interest rates profile via the dot points.  That leaves the USD in a sweet spot for the moment and further appreciation looks feasible in the near term.

As such, the current cyclical backdrop to the dollar remains very positive and we continue to look for a test of parity vs EUR in the near term.

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Yohay Elam

Yohay Elam

Yohay Elam: Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I've accumulated. After taking a short course about forex. Like many forex traders, I've earned a significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I've worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.