Price Parity: Is the USD Overvalued?

02/02/2010 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

The US dollar has had an incredible run over the past two months, leading many traders to wonder whether the dollar is overvalued. The answer is no! Based upon purchasing power parity, all of the major currencies are still very overvalued against the US dollar—particularly the aussie.

What does this mean? From a valuation standpoint, the dollar still has room to rise.


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Dollar bulls have banked some profits ahead of what will certainly be a volatile trading week. Yesterday’s US economic reports were mixed with manufacturing ISM rising from 55.9 to 58.4, the highest level in the more than five years, and construction activity, personal income, and personal spending all falling short of expectations. January was a good month for the manufacturing sector with activity accelerating in the US, UK, euro zone, and Australia. In the US, a pickup in export orders, employment, supplier deliveries, production, and prices contributed to faster manufacturing activity.

Yet what is most impressive is that the sector is continuing to expand despite the appreciation of the US dollar in December. The global pickup in manufacturing activity is largely tied to the expansion of manufacturing demand in China in the second half of 2009. However, signs of a slowdown in the Asian giant has begun to emerge, and combined with dollar strength in January, it will be interesting to see if the global improvement in manufacturing can be sustained.

Personal income growth slowed to 0.4% in December, while personal spending slowed to 0.2%. Incomes grew by a faster pace than expected, but the upward revision to the November data put income growth lower than the previous month. Given the sharp decline in retail sales in December, the slowdown in spending was not particularly surprising. According to the PCE deflator, inflationary pressures are also up modestly. Finally, construction spending fell at a much sharper rate in December, which confirms the disappointments that we have seen in new and existing home sales. On balance, these reports indicate that the economy is improving, albeit at a slower pace.

The dollar also benefited from the Obama administration's upward revision of GDP. The White House now expects the US economy to grow by 2.7% in 2010, up from their prior forecast of 2%. However, despite the improvement in growth, the jobless rate is expected to average 10% this year. Looking ahead, we expect the dollar to sustain its rally against the Japanese yen.

By Kathy Lien of GFTForex.com

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