Currency valuation

Every 6 months, we review our currency basket. For that, we need to calculate the "fair" price of all major currencies. We have our own methodology which takes into account most of the driving factors: future inflation, interest rates, M2, PPP... Our own calculations usually differ from what others have, but so far we are happy with our data because in the past we have seen the FOREX crosses tending to our prices.

What we had before was a market that was close to the fair value in all currencies except CHF (Swiss franc) and NOK (Norwegian krone), in which you have to pay a safety premium. This semester, however, the results of our analysis have been very different because under the strong turmoil we are living, a lot of drivers have changed. CHF doesn't appear overvalued anymore.

To answer the question "what is PPP (Purchase Power Parity)?" is the same as to answer "what would be the price of 2 currencies to buy the same basket of goods in the 2 countries?". We have seen a strong increase in prices in most of the countries exect the Euro zone (for instance, EURUSDppi=1.2 now, it was 1.1 last semester). You can tell what others try to do: they don´t want to pay the huge debt they own by creating inflation ON PURPOSE. It´s reasonable and it has happened in the past, but guess who is going to lose... But this is outside the scope of this article.

If we believe Eurostat (which we don´t), inflation in the EZ will be 2.4% for 2012. If we calculate our valuations with this data, the euro is expensive (more than 12% as an average) against the rest, except the AUD (Australian dollar). But, with our own data, we find out that:
  1. The CHF, CAD, USD, and GBP are around their fair value now!!
  2. AUD still has some room to run (until it reaches EURAUD=1.064).
  3. Valuation for EURJPY is going down, now 88.7 (bad for mortgages in yens).
  4. The best currencies to keep our savings are NOK (with a strong premium) and AUD, not CAD anymore.
Surprising conclusions. Perhaps, we will have to trust the market a little bit more.