The OECD says it's over-valued by 22%
U.S. President Donald Trump’s latest Twitter missive on financial markets holds water for some currency watchers.
Trump said Tuesday that the euro is “devalued” against the dollar, “putting the U.S. at a big disadvantage.” He may not be wrong: the common currency is over 22% undervalued versus the greenback according to the Organization for Economic Cooperation and Development’s purchasing-power-parity model. And then there’s the “Big Mac” approach to gauging currency valuations, which shows the euro is about 15% too cheap.
“The euro’s definitely undervalued on most measures,” said Kit Juckes, Societe Generale SA’s chief global FX strategist. “A persistent current-account surplus when unemployment is falling makes it hard to argue the currency isn’t undervalued.”
The euro briefly dipped following Trump’s tweet to a daily low of $1.1302, before rebounding to trade little changed at $1.1314. The common currency has weakened about 4% against the greenback over the past 12 months.
Other gauges suggest that valuations haven’t skewed too far from historical norms. A Federal Reserve dollar index that’s inflation-adjusted and trade-weighted is about 6% above its 20-year average. Meanwhile, the euro is about 6% below its average since its debut at the start of 1999.
“It’s well within the normal range of valuation,” said Adam Cole, chief currency strategist at RBC Capital Markets. “I don’t think there’s a policy of maintaining an undervalued currency, or holding it at undervalued levels.”
The euro is only a few percentage points undervalued, based on proprietary measures that show the exchange rate that would bring consumer prices to equal levels across countries, Cole said.
Valuation Matters
The dollar’s value is a concern for the U.S. administration if its strength makes American exports less competitive abroad. It’s also a worry for monetary-policy makers as it tends to restrain import prices, working against their efforts to boost inflation.
Fed policy is partly responsible for the euro’s valuation, according to Jane Foley, head of currency strategy at Rabobank International in London.
“The fact that the Fed has been the only Group-of-10 central bank to ratchet up a significant amount of policy normalization since 2015 certainly helped support the USD,” she said. “Of course, it can be argued that Trump’s tax cuts in 2018 increased the need of the Fed to hike last year.”