- The DEER strategy did not see positive returns since Aug 2021, primarily due to the JPY.
- JPY weakness has sustained despite low valuations and FX interventions.
- Uncertainty across interest rates has risen since 2020, bringing about higher entropy.
- The return of Trump also adds to uncertainty that could influence currencies.
- This could result in more volatility for the DEER Strategy’s returns, compared to earlier years.
Below is a summary; for full report and detailed charts, please download the PDF
The DEER (or DBS Equilibrium Exchange Rate) is a currency fair value metric derived through a statistical analysis of relationships between currencies and 1/price, 2/productivity, and 3/terms of trade differentials. These exchange rate factors are well established in the economics literature. Our prior analysis also found DEER to be a better indicator of fair values compared to oft-quoted real effective exchange rates (see DBS Focus: Assessing the DEER strategy for details).
In contrast to expectations, our rule-based DEER strategy to be short highly valued and long lowly valued G10 currencies did not see positive returns since Aug 2021. It is unlike the positive return profile for the strategy implemented from 2010 to 2019. This is illustrated by scatter plots of 1-year currency returns against carry-adjusted DEER valuations, which show that the slope of the line of best fit inverted in 2020-23 compared to 2010-19.
Does this mean an anomaly exists in FX markets, with overvalued currencies giving better returns than undervalued currencies? Not quite. We found that the overall slope for 2020-23 was skewed by just a single currency—JPY. Excluding JPY from the sample, the relationship between carry-adjusted DEER valuations and 1y returns turns back to negative, though it is less negative than the relationship observed during the 2010-19 period.
Thus, the recent empirical data elicit two issues about currency markets that have contributed to the DEER strategy’s underperformance from 2021:
1. An inverted relationship between JPY returns and valuations
2. A weaker relationship between carry-adjusted valuations and 1y returns
To read the full report, click here to Download the PDF.
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