I once again have collected price and interest rate data for 26 currencies.
I ranked the currencies according to four measures and I combined these rankings into four combined measures.
Good shorts are the Israeli shekel, the Hong Kong dollar, and the euro. Good longs are the Russian ruble, the Japanese yen, and the Mexican peso.
I invest based on statistics. For more on investing in statistically undervalued stocks see this freely accessible article. But you can also short overvalued currencies and use the proceeds to buy undervalued currencies. To keep track of currency valuations I publish articles like this one every month.
In my qualitative discussion of longs and shorts I will focus on currencies that can directly be traded with Interactive Brokers. Among the currencies in my quantitative analysis the Turkish lira, the Indian rupee, the Indonesian rupiah and the Brazilian real cannot be traded with Interactive Brokers.
4 currency trading strategies
Like last month I value currencies based on 4 statistical currency strategies:
- Changes in purchasing power relative to changes in purchasing power of other currencies. In other words: suppose the 5-year difference in inflation between 2 currencies is not compensated by a 5-year decrease in the value of the currency with the most inflation. Then a long position in that inflationary currency and a short position in the other currency is a statistically favorable bet.
- The term spread. This is the difference between long-term interest rates and short-term interest rates. Currencies with inverted or flat yield curves have better returns, at least on average. I use the difference between the 10-year yield and the 1-year yield.
- The 1-month change in the 10-year yield. The larger this change the better the statistical return of that currency.
- Momentum: I use 6-month raw price momentum.
For each of these 4 basic strategies I compute for each currency a rank number. Low rank numbers predict low, or negative, returns and high rank numbers predict high (positive) returns, at least on a statistical basis. Average rank numbers are computed for 4 combinations of currency strategies. I combine the following strategies: