FX: DEER recommendations (February 2022)
- The DEER Strategy recommends long positions in JPY, GBP, and CAD...
- ... as well as short positions in USD, CHF, and EUR
- The DEER Strategy has produced positive returns year-to-date, unlike other risk assets
- Non-correlated returns underscore its diversification benefit when added to traditional portfolios
- In Asia ex-Japan, MYR, IDR, and CNY rank the cheapest, while PHP, THB, and INR rank as the dearest
Within our basket of G10 currencies, the JPY, GBP, and AUD are ranked as the cheapest based on the latest DEER valuations. The JPY remains cheap, with its REER having recently touched its lowest point since 2015. GBP has also seen its under-valuation narrowing slightly, helped by a BoE rate hike in Dec and a more guarded stance towards inflation. AUD has overtaken the CAD as the third cheapest currency, with the RBA expected to lag other advanced economies in enacting rate hikes.
The USD, NZD, and CHF remain the three most expensive based on the latest DEER valuations. The USD has vaulted to the position of being most over-valued, supported by the Fed’s taper and expectations of four or more rate hikes in 2022. Both NZD and CHF have seen their over-valuation narrowed somewhat, though they remain expensive compared to their DEER fair values.
Our DEER strategy recommends being long JPY, GBP, and CAD. As previously discussed, our strategy explicitly accounts for interest rate differentials, or carry. The reason why the CAD was selected over the cheaper AUD is due to the fact that CAD offers a positive carry, while AUD offers a negative carry. This carry differential was sufficient to negate the very small difference in DEER valuations (CAD: -0.5%; AUD: -0.8%). The result is that our strategy sees a higher expected return in being long CAD than in long AUD.
Also, our DEER strategy recommends being short USD, CHF, and the EUR. Staying neutral on NZD is due to the strategy’s estimation that returns from the NZD’s mean-reversion may not offset the high NZD carry costs over the expected lifetime of the trade.
Recent DEER return breakdown and analysis
We examine the 3M returns of the previous DEER recommendations made on 5 Nov 2021 (see DBS Flash - FX: DEER recommendations (November 2021), 5 Nov 2021). These 3M returns are based on current spot prices and the 3M forward prices (vs USD) on 5 Nov 2021.
Our recommendations to short EUR and CHF notched a second consecutive quarter of positive returns, as Europe looks to lag the US in policy normalization and rate hikes. Our long GBP position also saw a positive return, with the BoE finally acknowledging the risk of persistent inflation and commencing rate hikes. Our JPY long posted a second quarter of losses, with the market pushing USD/JPY up to multi-year highs up on the back of rising US Treasury yields. An easing of supply chain bottlenecks for Japanese automakers and wobbly markets could have helped the JPY find a footing recently. Finally, our CAD long recorded the worst return despite another leg higher in oil prices. While the BoC has ended QE in October, the Bank has refrained from hiking rates thus far even as inflation reached a multi-decade high in December. On an aggregated basis, our DEER strategy posted a small gain of 0.4% since 5 Nov.
The DEER Strategy’s returns continued to show little correlation against both the S&P 500 and the Bloomberg Global Aggregate Bond Index. Indeed, the Strategy has posted a positive 0.7% return since the start of 2022, even as both the S&P500 and the Bloomberg Global Aggregate Bond Index saw losses of 4.9% and 1.7% respectively on the back of Fed rate hike fears. Such outperformance during market turmoil emphatically demonstrates how the inclusion of the DEER Strategy could offer additional diversification to traditional portfolios consisting of only equities and bonds.
Latest Asian ex-Japan DEER valuations
Within the basket of Asian ex-Japan currencies, the MYR, IDR, and CNY rank as the three cheapest. MYR’s under-valuation has widened further, as buoyant oil prices have not necessarily translated to outsize MYR strength amid political uncertainty. IDR remains cheap, with the Indonesia recording atypical current account surpluses recently. The CNY is still surprisingly cheap despite sizeable nominal appreciation. This could reflect the impact of modest inflation in China vis-à-vis elevated inflation in the rest of the world.
Meanwhile, PHP, THB, and INR continue to rank as the most expensive. PHP’s over-valuation has narrowed in recent months, but it is not sufficient to displace PHP from being the most expensive in Asia. The THB’s over-valuation has widened again, helped by a re-opening of the tourism sector. However, the BoT remains a long way from normalizing monetary policy. Finally, the INR remains somewhat over-valued, and could be pressured lower with equity inflows now waning.
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