- Nomura’s gauge takes opposite view to other valuation indexes
- U.S. currency weaker in 2016 as Fed starts two-day meeting
Investors accustomed to using the price of a Big Mac to tell whether a currency is cheap or expensive may have to reboot their thinking.
Nomura Holdings Inc.’s new iPhone index suggests the dollar is the most undervalued currency among 23 global peers, based on the cost of the Apple Inc. product in different countries. That’s the opposite conclusion of existing purchasing-power parity measures, such as The Economist’s Big Mac Index, which has the greenback as the fourth-most-overvalued currency.
The divergence comes as traders await the Federal Reserve’s announcement this week, which they’ll scour for clues to how quickly officials plan to raise interest rates. Higher borrowing costs would probably boost the dollar, which is headed for its first annual decline versus major counterparts in four years.
“The iPhone index should be a bit more reliable than the Big Mac index -- nobody will fly to another country to buy a Big Mac, whereas they might fly to another country for an iPhone,” said Bilal Hafeez, global head of foreign-exchange research at Nomura in London.
The new measure suggests that the Fed, which has cited concern about the dollar’s strength and its impact on restraining inflation, may be more comfortable raising rates if the greenback is deemed undervalued.
The Bloomberg Dollar Spot Index, which measures the U.S. currency against 10 peers, has fallen 2.8 percent this year after policy makers cut the number of rate increases they expect to make following a lackluster first quarter for the economy.
Signs the economic backdrop is changing -- June employment, retail sales and housing starts all beat analyst forecasts -- have prompted a re-assessment in the futures market that may boost the dollar, and prove Nomura’s iPhone index right.
While traders see only an 10 percent chance of a rate increase at the Fed meeting ending Wednesday, there’s now an almost 50 percent prospect of a hike by year-end, data compiled by Bloomberg show. That’s up from 15 percent on June 24, the day after Britain voted to quit the European Union.
Hafeez expects the dollar to strengthen to $1.05 per euro by year-end, from $1.0984 as of 12:21 p.m. in New York. That’s more bullish than the $1.08 median estimate in a Bloomberg survey. At the same time, he sees the U.S. currency weakening to 104 yen, from 104.86 now. That compares with a survey estimate of 105.
For years, many traders have used the Big Mac index -- which is based on the price of a McDonald’s Corp. hamburger -- along with an OECD gauge and measures based on consumer and producer prices, to determine currencies’ relative value. All of these show the dollar as broadly overvalued.
The iPhone index is better than its traditional peers because it uses the “defining product of the digital era,” Hafeez said. “IPhone is high-end tech,” he said. “That’s going to be the bigger driver in the future.”
Where an iPhone costs more in dollars terms, such as in Russia, that means the greenback is relatively undervalued compared with the local currency, and vice versa. Typical prices range from $649 in the U.S. to $705 in the U.K. and $1,213 in Brazil, according to Nomura. It can never be a perfect comparison because prices can also reflect local taxes and other costs, Hafeez said. Apple says it sold 231 million iPhones globally in the fiscal year ending September 2015.
The reason there’s a difference between the iPhone and Big Mac valuations is partly to do with differences in labor costs, Hafeez said. Producing burgers involves a lot of local labor, which is cheaper in developing economies and which makes their currencies look relatively undervalued.
Esoteric purchasing-power indexes are nothing new. Kit Juckes of Societe Generale SA says he’s concocted his own iPad index as well as measures based on the cost of lattes and martinis.
They’re a “lighthearted way of looking at fair value in currencies to support other measures, like fundamental exchange rates,” said Juckes, a strategist in London.
Juckes is “marginally bullish” on the dollar, predicting it will strengthen to $1.08 per euro before the year is out.
And with an informal survey, gleaned from his travels, showing martinis cost more in dollar terms in Paris than in New York, he says he doesn’t see a major rebound in Europe’s single currency, which has tumbled more than 3 percent since Brexit.
“That’s kept me from thinking we’ll get a big recovery in the euro,” Juckes said. “Unless something else drives it.”