In a note to clients today, Bank of America Merrill Lynch (NYSE:BAC) outlines the findings of a suite of equilibrium models for FX market.
In particular, BofA estimates a set of 12 models in five categories – PPP, Balance of Payments, Monetary Models, Real Interest Differentials and Behavioural Equilibrium Exchange Rate models.
"Estimating the extent and duration of over/undershooting from equilibrium remains a mixture of art and science, and it is important to interpret all such model results as one input for trading decisions, to be augmented with judgment informed by the macro picture, as well as inputs from other sources such as flows and price action," BofA advises.
Key Takeaways
"1- The most extreme misalignments to be in CHF and JPY and suggesting value in being short CHF/JPY.
2- USD overvaluation -- large at 15% -- is understandable given market expectations of Fed tightening and in fact should probably be bigger. We expect USD has scope to strengthen further. Conversely EUR is arguably not undervalued enough.
3- EUR is close to equilibrium, as is EUR/USD; a surprising result given monetary policy divergence which we expect will continue to be a powerful driver, and underpins our call for EUR/USD to move towards parity by the end of 2015.
4- AUD and NZD results are also surprising, with valuation suggesting both are close to equilibrium. We remain bearish on both – NZD more than AUD – as commodity weakness continues to bite.
5- The G-10 ‘petro-currencies’ – NOK and CAD – have understandably suffered the effects of plunging oil prices, bolstered by dovish Central Banks. NOK in particular appears to have over-shot however," BofA clarifies.