Investment Research 10 July 2017 FX Strategy Danske G10 MEVA: EUR/USD gravitational pull kicks in The gravitational pull for EUR/USD to move higher, which the Danske Mediumterm Valuation (MEVA) model has been pointing to for some time, has started to kick in. Also, MEVA still points to further fundamental upside for EUR/USD. More broadly, as an increasing number of central banks are set to follow the Fed in moving away from highly accommodative monetary conditions, fundamental factors are set to play a larger role in FX moves that could weigh on USD. With EUR/SEK not far from fundamentals as suggested by MEVA, it will probably require a key shift in Riksbank policy to allow the cross to grind lower. Something has changed since the last update of the Danske G10 MEVA model, 28 April 2017: fundamental model misalignments are now smaller across the board, except for GBP/USD where the UK election outcome has weighed. What has changed is the attitude of central bankers. Over the past few years, policy makers outside of the US have been eager to signal a willingness to ease, not least to avoid currency strength and, in our view, this has been key in keeping not least USD in overvalued territory for an extended period of time. However, since Mario Draghi let the end of further easing discussion out of the bag in late June, EUR/USD in particular has largely been given free rein on the upside, which fundamentals have pointed to for some time. Crucially, MEVA suggests that there is more to come for EUR/USD: with a fundamental level still around 1.27, gravity suggests the cross could be pulled higher still in the absence of new significant monetary-policy impulses. The MEVA estimates are, as expected, rather persistent, with the main changes since the April update being somewhat lower EUR/NOK and higher AUD/USD estimates. This is due mainly to movements in terms of trade. However, we stress that while NOK is included in the G10 MEVA framework for consistency, we do not recommend using the MEVA estimates for NOK due to the different FX dynamics at play in Norway, for details see Scandi Deep Dive into MEVA, 8 May 2017. Danske G10 MEVA model The Danske G10 MEVA model is a quantitative framework for bridging the short and the long term in the FX market by providing 'valuation anchors' for majors. MEVA falls into the class of behavioural exchange-rate models and is based on a panel cointegration model using a measure of the so-called Balassa- Samuelson effect as well as terms of trade. Given that MEVA has a half-life of around two years (i.e. less than most PPP models), we suggest using the signals as input for 1-3Y forecasts and hedging decisions. For a thorough introduction to MEVA, see FX Edge: Introducing the Danske G10 MEVA model (1 October 2015). G10 FX as seen by the Danske three-tier model framework: MEVA bridging the gap between our Short-Term Fin Models (STFM) and PPP STFM MEVA PPP MEVA Spot estimate current estimate estimate correction potential (Jul-17) (% rel to spot) EUR/USD 1.14 1.10 1.27 1.30 11% EUR/NOK* 9.51 9.48 9.42 8.38-1% EUR/SEK 9.62 9.63 9.43 7.81-2% USD/JPY 114 113 105 121-8% GBP/USD 1.29 1.27 1.67 1.68 30% EUR/CHF 1.10 1.09 1.25 1.30 14% AUD/USD 0.76 0.75 0.74 0.72-3% NZD/USD 0.73 0.71 0.69 0.65-5% USD/CAD 1.29 1.31 1.21 0.83-6% *While part of the G10 framework we do not advocate using MEVA estimates for the NOK. Source: Eviews, Bloomberg, Danske Bank Chief Analyst Christin Tuxen +45 45 13 78 67 tux@danskebank.dk Assistant Analyst Nicolai Pertou Ringkøbing nrin@danskebank.dk Important disclosures and certifications are contained from page 4 of this report. www.danskeresearch.com
In contrast, MEVA has historically worked well for EUR/SEK in the sense that model deviations have tended to correct relatively swiftly with a half-life of little more than half a year. Thus, it is interesting to note that EUR/SEK spot is in fact not too far from the 9.40 level, which MEVA pins down as fair. That is, MEVA hints that it is likely to require a significant shift in Riksbank policy in order for SEK to invoke on a broader appreciation trend as suggested by, for example, PPP. EUR/USD still undervalued despite the spot seeming less heavy EUR/NOK upside potential according to MEVA (i.e. contrast with PPP signal) EUR/SEK not too far from fair While MEVA and our PPP estimates generally agree on the fundamental direction given current spot levels, USD/JPY is an exception: standing at 105, the MEVA estimate points to downside from current spot levels while PPP at 121 hints at a bit more upside (that said, the suggested moves in either direction are not large in percentage terms). Recently, the Bank of Japan (BoJ) has been keen to point to its willingness to stay in the easing game while others have signalled the opposite, and as such JPY is still haunted by a central bank that has yet to leave the long-standing currency war behind. Indeed, looking at EUR/JPY, where MEVA puts fair for the cross at 133, potential for further yen weakness remains for now. Finally, speaking of shifts in policy, the Swiss National Bank will be keen to welcome an ECB that is moving towards the exit on negative rates as this - alongside fiscal/political risks which are now abating somewhat - has been key in keeping CHF overvalued for long. While MEVA estimates on CHF should be interpreted a bit cautiously due to the 1.20 floor in EUR/CHF in the years 2011-15, we note that both MEVA and PPP call for the cross to move higher, suggesting 1.25 and 1.30 as fair, respectively. As such, we would expect to see a sustained move above 1.10 in EUR/CHF on a 3M horizon. EUR/JPY: still a bit of JPY weakness left? Source: Eviews, Macrobond Financial, Danske Bank 2 10 July 2017 www.danskeresearch.com
USD/JPY now closer to fundamentals GBP/USD markedly below estimate but MEVA estimate set to come down EUR/CHF still lingering in undervalued territory AUD/USD fundamentals have stabilised and cross not too far away NZD/USD only slightly above MEVA estimate USD/CAD adding to overvaluation 3 10 July 2017 www.danskeresearch.com
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