USD/G10: Short-term valuations correcting – MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that the correction weaker for the dollar turned more abrupt yesterday with some sharp moves with the yen the clear out-performer in the G10 space.

Key Quotes

“We mentioned here on the first trading day of the new year on Tuesday that our short-term valuation models were indicating an overshoot of the dollar against some G10 currencies – in particular versus the yen, Australian dollar and Norwegian krone. The correction weaker for the dollar since has brought some of these currencies back more into line based on our short-term estimates.”

“The Norwegian krone is now back very close to fair value; however both the Australian dollar and the yen remain more over-valued relative to the historical norm. USD/JPY which was two standard deviations away from fair-value and nearly 4% over-valued corrected lower but so did our model! The same happened with AUD.”

“So, is this the start of a more meaningful correction for the dollar? While the speed of the advance for the dollar in Q4 certainly points to the potential for a further correction lower from here. The DXY index advanced by 7.1% in Q4 and reached its highest level since 2002 – reasons alone for some caution going into the new year. But a number of facts suggest to us that this is not the beginning of a more pronounced correction lower for the dollar.”

“Firstly, while speculative positioning of long dollars has certainly built up, IMM data does not indicate positioning has become excessive. Indeed, the latest available data to the week ending 27th December shows leveraged funds actually cut long dollar positions by a third from the previous week. Asset Manager/Institutional USD long positions remain relatively light.”

“Secondly, one catalyst for the dollar correction weaker has been actions taken by the Chinese authorities to squeeze speculative short CNH positions from the market. Their actions are working! The CNH overnight rate surged today while steps on capital controls have combined to see a sharp liquidation of short renminbi positions versus the dollar. But we do not think these actions will change expectations of a weaker renminbi or the trend of capital outflows that has been in place since mid- 2014 – highlighted by the near USD 1 trillion drop in reserves since then.”

“Finally, the Fed minutes, released on Wednesday evening didn’t really contain any new news but was nonetheless cited for reason to sell the dollar. The message from the minutes was clear – if fiscal stimulus is forthcoming, while it is unclear to exactly what extent it will impact the economy, the likelihood is that it may require an even faster pace of tightening than outlined in the Summary of Economic Projections in December (ie: three DOTS). So we doubt this dollar correction will extend much further with the US economy justifying current Fed rate hike expectations.”