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Overvalued dollar to weaken further if Fed fails to respond to higher inflation: MUFG

By on May 17, 2021 0

According to MUFG analysts, the US dollar (USD) remains overvalued in global currency markets. Inflation differentials will widen the gap and weaken the currency further if the Fed keeps interest rates close to zero.

Norwegian and Swedish currencies are still undervalued and in the best position to win, but Australian and New Zealand currencies are now overvalued, limiting the scope for further gains.

“Overall, the results support our fundamental macro views that there is still a possibility that the NOK and SEK will strengthen further and the USD will continue to weaken as US yields remain at less attractive levels than the US dollar. ‘before the pandemic. “

World Currency Valuation Table

Above: valuation table of world currencies

Dollar still overvalued after dramatic year of global currency movements

MUFG notes that there have been some very big changes in exchange rates over the past 15 months and takes the opportunity to look at longer-term valuations.

“Our long-term purchasing power parity valuation models show that the valuation of G10 currencies has changed significantly over the past year.”

According to MUFG, the biggest changes were seen in the Australian and New Zealand currencies. The bank’s model suggests the Australian dollar is now around 6% overvalued after being 11% undervalued last year, while the New Zealand dollar is now 12% overvalued against an under -valuation of 11% last year.

bannerThe Canadian dollar is now close to fair value after strong gains.

The Japanese yen is now considered to be 10% undervalued, little changed from the previous year, with the Swiss franc being 7% undervalued.

The MUFG considers that the Norwegian krone is respectively undervalued by around 15% and the Swedish krona by 24% despite a strong recovery.

Inflation trends will be important and higher inflation in the United States would further erode the estimate of the dollar’s fair value.

Notes from Goldman Sachs; “If, for example, inflation in the United States exceeds euro area inflation by 1% for five years, models would say that the EUR / USD ‘fair value’ would increase by 5%.”

Goldman adds that currencies can withstand longer-term pressures, but that depends on a central bank response to raise interest rates and boost real yields.

Against this backdrop, the dollar will be vulnerable to further net losses if the Fed does not respond.

The MUFG model shows that the euro is undervalued by around 13% and the pound 5% below the estimate of fair value. This suggests that the decline should be limited for the Euro / Dollar (EUR / USD) and Pound / Dollar (GBP / USD) exchange rates.