The Danske G10 Medium-term Valuation (MEVA) model continues to suggest that the USD is overvalued vs other G10 currencies.
Thus, if political woes and rate divergence fade in 2019, the USD is at risk.
Valuation corrections could notably be due in EUR/USD (higher) and GBP/USD (higher) whereas EUR/SEK may be sticky around 10, according to MEVA.
Since our August update, see FX Strategy: MEVA 1justifying weaker dollar policy , 23 August 2018, only relatively minor changes to fundamental estimates of the Danske G10 MEdium-Term VAluation (MEVA) model have occurred, see full table below and charts overleaf. Overall, the picture remains one of an overvalued USD.
MEVA still points to upside potential in EUR/USD with the estimate now at 1.30 (previously 1.31). Following the recent move lower in spot, this leaves a marked valuation gap. This is due to both the productivity-differential and the terms-of-trade component moving in favour of the eurozone vs US in recent years while Fed-ECB divergence has dragged the spot lower. As key triggers for a fundamental correction to be initiated we see either the ECB closing in on the first rate hike and/or the Fed going on hold .
The largest correction potential remains in GBP with MEVA having GBP/USD at 1.71 and EUR/GBP at 0.75. Model factors - notably terms of trade - have weighed somewhat on GBP lately. This implies that our so-called 'Brexit correction' (assuming a crude 10% deterioration in terms of trade as a result of Brexit) leaves our adjusted EUR/GBP estimate at 0.82 (previously 0.83). A GBP risk premium due to the risk of a no-deal Brexit is a key culprit in keeping sterling undervalued at present. But, the 'Brexit correction' also illustrates that Brexit will in itself shift GBP valuation lower and thus limit appreciation.
In the Scandi sphere, the MEVA estimates hint at limited correction potential in both NOK and SEK. While we favour PPP estimates to assess EUR/NOK valuation (suggests the cross is overvalued), MEVA continues to provide crucial hints as to why EUR/SEK could be sticky around - and possibly above - 10 for longer, despite the widely accepted notion that SEK is very overvalued (derived from PPP models). MEVA 'explains' a high EUR/SEK by a combination of productivity differentials and terms of trade favouring EUR.
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