- The DEER Strategy recommends longs in JPY, CAD, and AUD, and shorts in USD, CHF, and EUR.
- The strategy posted a small positive return over the last 3 months.
- JPY has been a standout, rebounding strongly from its low since July.
- CHF’s overvaluation is approaching its Aug 2011 high that triggered a EUR/CHF price floor.
- In Asia ex-Japan, CNY, IDR, and MYR are most under-valued, while PHP is most over-valued.
Across major G10 FX, the JPY and CAD are the most under-valued, with AUD close to fair value. JPY was so undervalued that it had triggered multiple rounds of buying interventions in April, May, and July this year by Japan, before staging a rapid rebound as speculative shorts were unwound. CAD has softened with two consecutive BOC rate cuts, while AUD has depreciated with an unwind of carry trades.
USD, CHF, and EUR are now the three most over-valued among major G10 currencies, with NZD ceding its position to EUR. The USD’s over-valuation has narrowed as Fed rate cut expectations deepened. CHF has strengthened towards its record high given an unwind of carry trades, despite two consecutive SNB rate cuts this year. EUR has recovered from its French election-triggered losses.
DEER Strategy Recommendations
Our DEER strategy continues to hold longs in JPY and CAD, but will rebalance from GBP to AUD long. JPY has staged a solid rebound from its July lows. USD/JPY was overly stretched and highly vulnerable in early July, making the eventual unwind of JPY carry trades particularly forceful. The unwind was triggered by a confluence of factors, including market interventions by Japan, criticism of the weak JPY by Trump and Japanese politicians, risk aversion from a sell-off in equities, and BOJ surprising markets with a rate hike on top of QT in its July policy meeting. JPY could continue to appreciate on a narrowing monetary policy gap. BOJ is just starting to wind down JGB purchases, and it has also signalled the possibility of further rate hikes, even as the Fed and ECB are poised for rate cuts.
The strategy retains shorts in USD, CHF, and EUR. The USD has depreciated somewhat since July, as previous expectations of US economic exceptionalism have proven too rosy. But the extent of overvaluation remains high, and is also significantly above what rate differentials and capital flow factors would suggest. Given disappointing non-farm payrolls in July on top of sharp US equity sell-offs, markets now see a chance for a 50bps Fed rate cut in Sep. This should further pressure the elevated USD, which has also not shown any safe haven quality during the unwind of carry trades.
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