• The Economist Magazine recently published an update on its much followed take on the Purchasing Power Parity theory, the Big Mac Index which compares the price of the ubiquitous burger in Golden Arches around the world. If, once converted in to dollars, the Big Mac prices vary then this arguably indicates the relative expensiveness/cheapness of the currency versus the US dollar. Using this methodology, burgers have suddenly got much cheaper on a relative basis in Buenos Aires, Rio, Cape Town and Istanbul as Emerging Market currencies have taking a kicking. The numbers show the renewed strength of the greenback this year which leaves only Switzerland and Sweden having more ‘expensive’ currencies than the dollar using this metric. Pre-Brexit Blighty remains a relatively cheap place for Burgerphiles with sterling looking around 20% undervalued against the dollar and whilst dining in Maccy D’s you can also enjoy the highly regarded Flake Raspberry McFlurry for pudding, all washed down with a Belgian Chocolate Honeycomb Iced Frappe…or maybe not. Other retailers of highly calorific convenience foods are available.
  • The big question is whether the dollar will continue to strengthen. It has been propelled this year by the superior performance of the US economy, political shenanigans in Europe, its ‘risk-off’ appeal in turbulent times and to an extent by the yield differential between US Bonds and those of the other major developed economies, though this has been largely offset by hedging costs. Our sense is that these following winds are very much ‘known knowns’, aligned at the same time and already well baked into the price. This being the case, we don’t see huge upside from here and with the potential for weakness should some of the pro-dollar/anti-euro factors reverse.
  • The fate of sterling is totally bound up with the Brexit negotiations. As I discuss in the end-piece on Brexit, Schroder Investment Management conducted an informal poll amongst the investment banks and economic consultancies to quantify the effect on sterling of either a ‘no deal’ or the completion a Withdrawal Agreement and concluded levels of USD/GBP at 1.10 in the event of a no-deal but 1.40 should an agreement be reached. For the next six months sterling will continue to reflect the probability of the two dramatically different scenarios, only one of which can happen and at 1.30 is currently indicating that a deal is more likely than not (i.e. it is trading closer to the top end of the band than the bottom).
  • For the reasons noted in the EM section, many of the EM currencies have taken a real battering so far this year. The Turkish lira has collapsed, tumbling down by over 30% against the US dollar this year. The fall in Lira fuelled an already smouldering fire across several EM currencies with the Mexican peso, the Brazilian real and the South African rand also falling sharply. In Argentina, a perennial EM disaster-in-waiting, the currency collapsed to the point where the Central Bank was forced to raise short-term interest rates from 15% to 60% in an effort to protect the country’s dwindling currency reserves.
  • Rather under the radar the Chinese yuan has fallen 10% against the dollar since March. The yuan’s weakness reflects concerns over a slowdown in the Chinese economy and, of course, the trade war with the US.

Summary: The US dollar has rallied this year as political travails and disappointing economic data proved headwinds to the euro and sterling. EM currencies have been very weak during the summer.  Predicting FX movements remains as fraught as ever and we are not basing any significant portfolio decisions on currency forecasting.

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