The Australian dollar is as much as 30 per cent overvalued and Australian investors should consider their currency exposures on the back of slowing growth in Asia and falling demand for commodities, says the global head of currency management at State Street Global Advisors (SSGA).
Boston-based senior managing director Colin Crownover says SSGA’s analysis indicates Australian investors should plan for the Australian dollar to pull back from the record levels it has touched over the past year.
Crownover notes that commodity currencies generally look overvalued, with the Australian dollar the leading example.
“We look at the Australian dollar as being almost 30 per cent overvalued at least versus the US dollar. That is a significant mis-valuation.
“But we don’t see it collapsing back to its fair value because there are relative growth reasons why it should be on the strong side.”
SSGA’s analysis indicates that the Australian dollar’s fair value is somewhere around the mid-70-cent mark to the US dollar.
Crownover sees Asian exporting nations that are exposed to a eurozone slipping into recession as experiencing slower growth.
He singles out China, predicting that economic growth there will be about 7 per cent this year and could slow by more if the government does not opt for a substantive fiscal-stimulus package.
For Australian investors looking at their currency exposure to US-dollar assets, Crownover forecasts that the US dollar will strengthen. He points to OECD economic indicators showing US and Japanese economies holding up against a backdrop of slipping world economic growth.
Crownover also notes that investors will lower exposure to the eurozone, pushing more allocations towards US-dollar-denominated assets.
Any risk-off selling around a eurozone market event will also put further upward pressure on the US dollar, according to Crownover.
The US dollar is as much as 10 per cent undervalued relative to other major currencies, he says, and also sees the economic growth gap between the US and emerging markets narrowing in the coming year.
“We are bullish about the US dollar and not because the US economy is without its problems,” Crownover says, “but currencies as always are a relative endeavour and of the major economies the US economy has lesser issues than the others.”
For investors looking to manage their emerging-market-currency exposures, Crownover warns that conventional wisdom can be misleading.
It is common for investors to hold broadly unhedged positions in emerging markets, with the view that over time emerging-market currencies will appreciate against most developed-market currencies on the back of relatively strong economic growth and healthy sovereign balance sheets.
Crownover says there are times when this buy-and-hold strategy for emerging-market currencies has played out – such as the period leading up to and during the financial crisis – but over the long term this approach has not paid off.
Pointing to an average hedge ratio of 40 per cent for the industry in Australia – considerably below hedging ratios internationally – Crownover advises investors to think about lifting this to around 50 to 60 per cent as a medium to long-term strategic decision.
“The Australian dollar being significantly overvalued, maybe this isn’t the right time to move to what we think is a good strategic ratio, but maybe you want to be a bit lighter than that now and take more exposure to foreign currencies because they look relatively cheap.”
