Tuesday, July 7, 2009

Euro most overvalued currency according to PPP index

It's been a few days since my last post, but hey I took it easy this Forth of July weekend! But I haven't been sitting still when it comes to the Forex markets! Checking in daily for news and quotes.
What's going on today heh? Stocks down, oil down, dollar up against most majors. Concerns about the economy because Obama's economic adviser suggested that a second stimulus package may be needed. Basically an indicator that the economy is still in a lot of trouble and investors lost confidence.
During my research I found something interesting. The PPP index with the EUR/USD pair.

The what index? PPP, Purchasing Power Parity index. Basically this index is described as follows;

"One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar."

- DailyFX

This is an interesting index. What makes it interesting is that it shows that the Euro is almost trading 3000 pips in overbought territory! In my opinion unbalancing the world economy, but over time it will correct itself, as soon as the US economy is stabilized.

Purchasing Power Parity (PPP) of Gross Domestic Product for the countries of the world as of 2003. The economy of the United States is used as a reference, so that country is set at 100. Bermuda has the highest index value, 154, thus goods sold in Bermuda are 54% more expensive than in the United States.

Although an old map (2003) this is the only recent PPP map I could find. But it kind of gives a clearer view of what the PPP really is.
So what does this mean right now for the EUR/USD pair. Well, something that I sort of already knew but could never really confirm until now.

The pair is on it's way down. The question is how quickly. What time frame we are looking at? That the Euro is not able to breach the current resistance levels doesn't mean it's time to sell now. I'm talking in the long run. By the end of the year I can almost guarantee you it's going to be a lot lower, probably trading in the 1.20 - 1.25 range. But where an entry point is, that is the big question. I'm going to continue to follow this pair, although I'm still interested in commodity pairs as well.

Oh, by the way, another issue of Currency Trader magazine has been released;


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