For much of the past 3-4 years, our quarterly Currency Strategy has recommended small, fundamentally strong peripheral G10 currencies at the expense of their money-printing G4 counterparts. Until the beginning of this year this strategy worked relatively satisfactorily. However, since Q1 currencies of smaller countries have underperformed their larger and more liquid peers. Partly of course, this simply reflects their overvaluation due to previous appreciation; this was especially true for the AUD and NOK and continues to apply to the NZD and CAD. Apart from the obvious trade-related problems that several of these otherwise fundamentally strong countries were to face (as the exchange rate became too high) imported inflation was also suppressed, which made their inflation targets harder to reach. Additionally, to complicate matters even further absent any real inflation but with a strong exchange rate the pressure to lower policy rates has inflated local property markets even more. In Sweden the debate on how to reach the inflation target while taking into account the risk of developing a housing market bubble has been rather infected. In this edition of FX Ringside we describe the various different approaches to the problem already taken and measures adopted in peripheral countries and the potential impact this may have on central bank policy and ultimately the exchange rate. Since this is clearly a developing subject, our discussion is intended to be descriptive rather than exhaustive
Read the full report: FX Ringside
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