Why Nordic currencies are 20% undervalued
Ugo Lancioni (pictured) is senior portfolio manager and head of Global Currency at Neuberger Berman.
The New Year has started positively with US equity markets reaching all-time highs and relatively low levels of risk aversion, despite the high degree of political uncertainty. In the US, fundamentals are robust and improving.
With the Federal Reserve expected to hike their policy rate two or three times in 2017, the US dollar could take another leg higher. However, although recent US domestic data have been very strong, we believe this has already been reflected in the price of the US dollar.
Therefore, should the data fail to satisfy this level of optimism, especially with respect to the implementation of President-elect Donald Trump’s policies, the dollar may suffer.
Continental Europe, after three years lagging behind the US, the gap has started to narrow. Data have been surprising on the upside with many indicators pointing towards stronger growth for 2017. In December, the European Central Bank extended its Quantitative Easing program, albeit at a reduced level of monthly purchases.
However, the market is not pricing the possibility of a further reduction in the ECB’s easing policy, which, in a reflationary environment, could see European rates move higher and offset the stronger US dollar.
So where should investors be looking from a currency perspective? Our analysis suggests that Scandinavian currencies, which are closely linked to the European trading bloc, remain significantly undervalued: between 15 and 20% relative to other major currencies.
Swedish data, for example, have been much stronger lately and the combination of stronger data and higher inflation could lead to an adjustment higher in the Swedish krona. We believe that Scandinavian countries in general could outperform other G10 countries this year.
In terms of overvalued currencies, our analysis suggests the Swiss franc is significantly overvalued relative to the other major currencies. The Swiss National Bank is pursuing a negative interest rate policy and remains active in the currency markets to mitigate any franc appreciation. Moreover, as global yields move higher the Swiss franc will come under pressure as interest rate differentials widen in favour of a lower franc.
Elsewhere, the Japanese yen sold off dramatically in the fourth quarter of 2016 and reached levels that are beginning to look stretched. We believe the yen is vulnerable to a correction, especially if markets experience some turbulence in high yielding assets.
Commodity-dependent currencies such as the Australian dollar, New Zealand dollar and Canadian dollar may underperform relative to other major currencies. This suggests that following the popularity of the carry trade in the second half of 2016 these currencies are overvalued from a long-term fundamental perspective. Should volatility increase, we may expect these currencies to come under pressure.
Finally, China has changed the currency weightings in the basket used to fix the renminbi, reducing the weight of the US dollar. Moreover, there is evidence of aggressive intervention in order to limit capital outflows from the country. Investors should monitor the situation in China closely because the global implications of developments in China and its currency could be significant.
There is scope for further gradual US dollar appreciation in 2017 if the data remain strong. However, a near-term correction is to be expected as the market is keen to assess the likelihood of success of the new administration’s policies. More details need to be unveiled.
European currencies will offer good value from a longer-term perspective if we enter a reflationary phase. Political uncertainty is likely to stay with us for a while.
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