While not quite as cool sounding as “the most interesting man in the world” the most overvalued currency could actually help you make money. Interesting doesn’t pay like over/under valuation. So what is the most overvalued currency in the G-10? If you guessed the Australian Dollar you win. Across pairs the AUD is consistently the most expensive currency and has been for a while.
Why is the AUD so overvalued? They never had a housing crash like in the US and southern Europe, they have strong natural resources, up until this year investors kept believing that China can save all, and last but not least they had the highest short term interest rates in the G-10. With high relative interest rates the AUD has been the carry trade of choice and consequently has been one of the go to “Risk On” trades since the 2008 crash. How high have rates been relative to the rest of the G-10? Below is a chart of G-10 90-day rates. (Click on chart to enlarge)
G-10 90-Day Interest Rates
Combined with the ZIRP or near ZIRP policies in most of the world the AUD has attracted a lot of money looking for yield. Of course you then have to ask is this yield safe? Judging from the slowdown in China and the drop in Australian interest rates we question the safety of this trade, of course we question anything that is considered safe.
So how overvalued is the AUD? Well using PPP-purchasing price parity as our valuation gauge here are a few charts showing how extended it really is. Our first chart is of the EUR/AUD. Here the AUD is “only” 20% overvalued.(Click on chart to enlarge)
Next up is the AUD/CAD. Here you would think the relationship would be closer since the makeup of their economies is similar with commodities making up such a large part. Of course Canada is tied to the US and Australia is tied to China. Either way the AUD/CAD is overvalued to the tune of 27%.(Click on chart to enlarge)
Looking at the AUD/JPY things continue to get worse as the Australian Dollar is overvalued against the Yen by 40%.(Click on chart to enlarge)
Up last we have the worst case of overvaluation of the group. The AUD/USD is ridiculous for several reasons but the one we are looking at today is that it is overvalued by over 50%.(Click on chart to enlarge)
As you can see by the charts currencies have their share of value fluctuations but like most of finance things are rarely different and it is hard to fight reality forever. Trading currencies based on valuations is not for the impatient as it can take months and even years for things to come back in line but as evidenced by the above charts once the pendulum starts to swing the other direction it tends to carry it for some time. With China slowing down and the RBA in a rate easing cycle we think that the pendulum is ready to swing the other way.
*-We deal primarily in G-10 currencies. AUD is not the most overvalued currency on the planet, but is the most overvalued currency in the industrialized world.
Disclaimer-In our model portfolio we are short the AUD