Forex Institutional Research: Deutsche Bank FX Daily

Forex Institutional Research: Deutsche Bank FX Daily

Key quotes from the Deutsche Bank FX report: 

Who’s hot on the bloc

Valuation differentials across the dollar bloc are at all-time highs. The Antipodes are 15% too expensive on PPP while CAD is 5% too cheap. This spread is historically extreme and offers relative value in the medium term. Other structural factors are also aligned for CAD to outperform the Antipodes.

First, Canada may see faster terms-of-trade improvement than its peers.Our commodity strategists expect iron ore prices to revisit $40 in the second half of the year, and milk prices show no sign of being lifted by European supply cuts. Canadian exporters, by contrast, should start to benefit from the process of supply rebalancing being firmly underway in crude oil, with our strategists expecting WTI to rise toward $47 by year-end. Similarly, their end-2018 forecasts of $49 for iron ore and $65 for WTI are consistent with AUD/CAD falling towards a fair value of 0.82 on our PPP model.

Second, relative domestic business cycles are unlikely to support Antipodean outperformance indefinitely. Investment in Australia and New Zealand is likely to decline further as the construction booms abate. Slowing house price inflation also threatens the recent acceleration in private consumption. And unlike in Canada, there is little scope left for further fiscal stimulus instead of monetary easing.

Third, Canada’s productivity growth has not lagged Australia’s significantly. Since the GFC, when all three currencies were close to PPP in effective terms, labour productivity has grown by 9% in Australia versus 6% in Canada. Effectively the gap is even smaller since Australia’s competitors in Asia have also achieved higher productivity growth than Canada’s competitors in North America. But to the extent that Australia enjoys a productivity edge over Canada, this is not nearly enough to compensate for its extreme currency overvaluation. For New Zealand, the issue does not even arise as its economy has had one of the poorest productivity track records in the developed world for many decades, and especially in the crucial tradables sector.

Hence, we expect CAD to outperform its dollar bloc peers as they all converge to PPP. In half-life terms, the historical speed of convergence is two years for NZD and six months more for AUD and CAD.

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