The "strong dollar" storm is sweeping the globe, but is it really as expensive as it seems?
UBS pointed out in a report on Thursday that, according to the latest G10 foreign exchange fair value model, the dollar's valuation is still far from extreme levels, currently overvalued by about 2.5%-5.5%, much lower than the 20-25% overvaluation suggested by the analysis estimate.
The model adjusts the standard OECD estimate of G10 purchasing power parity, incorporating relative productivity (GDP per capita) and trade conditions.
UBS notes that the dollar's overvaluation is mainly due to the strong growth of the U.S. currency relative to other G10 currencies, as well as the rise in commodity prices.
However, the degree of the dollar's overvaluation is not as severe as the simple PPP model suggests, which helps to explain why the dollar has remained strong recently.
In terms of other currencies, the yen is undervalued by about 25%, while the euro is undervalued by 5%.
UBS points out that the euro's decline is mainly due to the adverse effects of trade conditions, that is, the price increase of imported goods in the eurozone is faster than that of exported goods, as well as poor growth performance relative to the United States.
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The yen's decline is also due to similar reasons, on the one hand, it is the negative impact of trade conditions, that is, the price increase of imported goods in Japan is faster than that of exported goods; on the other hand, the further expansion of U.S.-Japan interest rates, the dollar's yield is significantly higher than that of the yen, making holding dollars more attractive to investors.
In terms of other currencies:The Australian dollar, New Zealand dollar, and Scandinavian currencies are undervalued, with the Australian dollar being undoubtedly the cheapest, although the fair value estimated by the model may be overly optimistic.
The Canadian dollar and Swiss franc are overvalued, with the Canadian dollar being overvalued due to Canada's poor productivity performance.
The Swiss franc is also overvalued, even though its fair value is much lower than standard estimates. This reflects that inflation differences will continue to push down the fair value of the euro/Swiss franc.
The British pound and New Zealand dollar are considered close to equilibrium, meaning they are neither overvalued nor undervalued.
Furthermore, the International Monetary Fund (IMF)'s FEER model indicates that the US dollar is overvalued by about 10%, and UBS points out that this figure may be revised downward in the next update as the US current account deficit narrows.
In addition, most of the US dollar's overvaluation is against emerging market currencies, and among the G10, only the Swedish krona and Japanese yen are considered cheap. It is worth noting that the euro is slightly overvalued, which largely reflects its rebound from the lows of 2022.
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