Four rather sick patients

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This post is a guest contribution by Niels Jensen, chief executive partner of London-based Absolute Return Partners.

Earlier in the year I had the pleasure of having lunch with hedge fund manager John Paulson. When asked what he anticipated to be the main driver of investment returns over the next few years, he responded without hesitation: “Currencies”. I thought long and hard about that answer and haven’t been able to get the discussion out of my head since.

John Paulson’s logic is simple. The world is in the unprecedented situation of all four major trading currencies (EUR, GBP, JPY and USD) facing their unique set of challenges. But not all four can fall at the same time. Currencies are unique in the sense that they are relative as opposed to absolute trading objects. You don’t just buy dollars. You buy dollars against some other currency which is why they can’t all fall at the same time.

The world has already caught on to this, with the financial media falling over themselves in recent weeks, competing to present the goriest story about how competitive devaluations will take down the world as we know it today. The scaremongers may have their day in the sun, but ultimately common sense will prevail and currency traders will have to go back to focus on housing starts again.

Morgan Stanley published a very interesting research report only last week in which they produced estimates of how much the major trading currencies of the world need to appreciate (depreciate) vis-à-vis USD in order to bring their current account surplus (deficit) within 4% of GDP, which Morgan Stanley have used in their model as the threshold level. Please note that the changes in exchange rates suggested by Morgan Stanley’s model do not reflect their actual views on those same currencies – the model is purely theoretical but provides a good illustration as to how much out of whack many currencies are today.

Chart 1:  G10 Misalignment from Model (2011-15)


As per Morgan Stanley’s work, in the context of G10, only CHF is seriously undervalued vis-à-vis USD with a 20% appreciation required in order to bring the Swiss current account surplus down to a more reasonable 4% of GDP – see chart 1. On the other hand, outside G10, many emerging market currencies are currently significantly undervalued, with SGD standing out as the worst culprit, being over 30% undervalued – see chart 2.

Chart 2:  EM Misalignment from Model (2011-15)


Click here for the full report.

Source: Niels Jensen, Absolute Return Partners, November 17, 2010.

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