Kathrein Currency Model

The short-term Kathrein EUR/USD Model is a combination of trend following indicators and the expectation for short-term interest rates.

The following graphic illustrates the development of the euro versus the U.S. dollar as well as the respective status of the model for the first quarter 2012. During times of positive cash to assets ratio, the model recommended purchasing euros, while during times of negative cash to assets ratio the model signals purchasing U.S. dollars.

During Q1 the U.S. dollar fluctuated in a range between 1.27 and 1.34. During this period, the euro appreciated 2.97% against the U.S. dollar. The Kathrein model signaled purchasing USD from the beginning of the year through the end of January. During the second week of February, the model switched to sell USD and purchase EUR. Both signals were implemented at 50%, gains and losses balanced each other out during the first quarter. Through the 50% short signal to the U.S. dollar, the currency risk of the U.S. stocks in the Kathrein Asset Allocation Funds is 62.5% hedged.

Purchasing power parity states that the same goods must have the same price in various currencies, otherwise market forces would equalize prices and exchange rates. With identical bundles of goods, different rates of inflation would ultimately affect the exchange rates. A country that has a sustained 10% higher inflation rate would have to depreciate its currency by 10% for its traded-goods to regain equal purchasing power. Reality is not as exact as the purchasing power parity theory assumes, but extreme deviations from the nominal exchange rate provide good signals for a period of about two to three years.

Currently the nominal exchange rate is at 1.33 USD for 1 euro and a standard deviation of 10 cents. More conclusive is the value of two standard deviations, currently 1.54 USD. Historically, this value has not been exceeded for more than one or two years. Only in 1985, at the end of the high interest rate cycle in the U.S., did it take three years for the USD to come back down to parity levels, albeit at that point very drastically, from 0.6 to 1.2 within only three years.