However, within the risk-on/risk-off framework, there are opportunities for arbitrage, traders say, with some currencies more overvalued than others.
Apart from the traditional measure of purchasing power parity, key metrics for determining a currency’s value are the relevant economy’s productivity growth and terms of trade (the quantity of imports that can be purchased by a fixed quantity of exports), according to analysts at Deutsche Bank. Based on those metrics, EMEA and Latin American currencies are about 10 percent overvalued in aggregate, while Asia becomes more attractive.
In EMEA, the most overvalued currencies are those of the Czech Republic and Hungary, at 26 percent and 19 percent respectively, while Poland and South Africa are about fairly valued.
“There are big differences between currencies when judged by terms of trade, with the Czech Republic, Hungary and Turkey in significantly overvalued territory,” said Deutsche Bank strategist Henrik Gullberg. “This is in stark contrast to South Africa, in particular.”
Among the Latin American currencies, the Brazilian real is the most overvalued at around 30 percent, he said, while the Mexican peso and Chilean peso are both undervalued.
Picking performing currencies has become increasingly difficult in recent months, analysts say, as high levels of correlation are common.
“Risk-on means rising commodities and a falling dollar, so a rising euro, while risk-off is the opposite,” said Kit Juckes, a strategist at Société Générale. “Correlation levels are incredibly high and the relative merits of an individual higher-yielding currency are not as important as the starting reality of getting out of the dollar.”
Still, some preferred positions are emerging within the risk-on environment. Kiaran Kowshik at BNP Paribas is bullish on the South African rand and Scandinavian currencies. He is, however, doubtful about the merits of strong risk appetite.
“There are a lot of reasons to suggest that it might make more sense to focus on risk-off,” he said. “Some currencies, such as the Australian dollar, are overvalued and I would look to get out of those now.”
In April the Australian dollar hit its highest level against its US counterpart for 29 years, and was recently trading at $1.067, after a 10 percent rise since mid-March.
The dynamics of the risk-on and risk-off environment mean that investors sometimes need to take the opposite position from their view, said Geoffrey Wu, a strategist at UBS.
“Although profitable initially, selling [non-dollar] risk means that policymakers are concerned over sentiment. But then the rhetoric changes and markets price back in more policy accommodation – risk shorts are stopped out and the only way to make money is to jump on the ‘dollar-carry’ bandwagon,” he said.