Tags: china | trade | deal | investors | tariffs

Currencies Only Trade at Fair Value by Accident

Currencies Only Trade at Fair Value by Accident
(Valeriy Bochkarev/Dreamstime)

Monday, 04 March 2019 09:43 AM Current | Bio | Archive

The story of the shepherd boy who repeatedly tricks nearby villagers into thinking wolves are attacking his flock is relatively well known across many cultures.

When a wolf actually does appear and the boy again calls for help, the villagers believe that it is another false alarm and the sheep are eaten by the wolf.

On another matter entirely, on Saturday, President Donald Trump worried about the dollar being too strong.

 “We have a gentleman that likes a very strong dollar at the Fed,” he said. “I want a strong dollar, but I want a dollar that’s great for our country not a dollar that is so strong that it is prohibitive for us to be dealing with other nations,” Reuters reported.

In the meantime, the dollar hasn’t weakened and the dollar index DXY is practically unchanged from Friday’s close  at around 96.60 from Friday’s close at the moment of this writing (6:00 am NY time)

Nevertheless, it is a fact that the dollar is indeed stronger than “fair value” suggests when we take into account producer price data of the various economies that are concerned to establish the dollar’s “theoretical” equilibrium price.

Investors could get an idea of what the “Purchasing Power Parity” of the dollar is by taking a look at the University of Columbia’s Sauder School of Business daily publication of the purchasing parity power of the U.S. dollar.

For example, as calculated on March 1, the euro was about 14 percent undervalued against the U.S. dollar and the British pound about 8 percent undervalued against the dollar

Investors should always keep in mind that currencies only trade at fair value by accident.

Besides that, the degree of dollar overvaluation against fair value is not enough to do serious damage to U.S. economic competitiveness, especially when compared to the effects of some rather severe trade tariffs.

On that point, facts show that the cost of the trade tariffs has been borne almost entirely by U.S. companies or U.S. consumers in some cases.

So, there is good news then in the further news reports over the weekend that the United States and China could lift some tariffs imposed last year, and Beijing would agree to ease restrictions on American products, The Wall Street Journal reported.

That would help the competitiveness of U.S. companies that depend on Chinese goods as inputs into their production process. Of course, this should have a positive effect on earnings of U.S. companies.

This should also help investment decisions by companies who do seem to have being delaying capital spending amidst uncertainty over trade.

There will of course be a risk premium to include into future investment decisions that involve the United States. So, reversing the tariffs wouldn’t take us right back to where we were before all this began.

For equity markets, the upside from this sort of news is now fairly limited.

If all or nearly all U.S. trade tariffs or in other words equity taxes were reversed, this would still be a positive signal for financial markets, but the general expectation is that a deal will be done and that’s reflected in today’s stock prices, which show a “risk-on” bias on the U.S.-China trade or tariffs news.

Again, the risk-on bias is not shared by the dollar that remains, at least so far, around the levels of Friday’s close

From the eurozone, we got this morning producer price inflation (PPI), which is something for investors to take note of, especially as this week on Thursday, the European Central Bank has its monetary policy meeting and is expected to give what they call “forward guidance” on when the ECB thinks it could start reversing its actual easing monetary policy.

Producer prices (ex-construction) for the Euro Area rose for the first time in three months in January. A 0.4 percent monthly advance was marginally larger than expected but only enough to leave annual PPI inflation unchanged at December's 3.0 percent rate. The core PPI was up 0.3 percent from year end while the 12-month rate came down from 1.3 percent to 1.2 percent, its weakest print since December 2016.

Please don’t overlook the fact that January tends, seasonably, to be a stronger month for the PPI.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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The dollar is indeed stronger than “fair value” suggests when we take into account producer price data of the various economies that are concerned to establish the dollar’s “theoretical” equilibrium price.
china, trade, deal, investors, tariffs
Monday, 04 March 2019 09:43 AM
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