Trends Developing In The Forex MarketNovember 21, 2014
As most investors are aware, there have been some major currency moves recently (looking at you Yen/USD cross). This has established some interesting trends in the forex market. For example, volatility continues to rise off a very low base (unlike in the equity market). In the chart below, we plot the VIX (right-hand scale) against the average 65-day realized volatility of major currency pairs (left-hand scale). Forex volatility has increased to its highest level since November 2013.
Some long-term purchasing power parity relationships have also changed. For instance, the Euro is now undervalued on a purchasing power parity basis against the USD really for the first time since 2012. And the Pound is now undervalued again after spending most of 2014 overvalued.
The Yen is now undervalued against the dollar by the greatest percentage since late 1985.
The overvaluations of the commodity currencies such as the Canadian dollar and the Australian dollar have fallen substantially. The Canadian dollar is approximately 5.5% overvalued against the USD on a PPP basis. This is the lowest overvalued percentage since 2009. The Aussie dollar is still 16.5% overvalued but down from 47% overvalued in 2011.
Finally, the nominal and real trade-weighted dollar index are both at five year highs.