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By XE Market Analysis April 28, 2021 5:14 am
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    XE Market Analysis: Europe - Apr 28, 2021

    Finally the dollar has found its feet, with the narrow trade-weighted DXY index posting two consecutive day of higher highs for the first time since late March. The index printed its loftiest level on the week so far at 91.13, extending the modest rebound from Monday's eight-week low at 90.68. This has been concomitant with longer-dated Treasury yields putting in their most sustained rise in a month, with the 10-year note yield pushing on 1.65% today, up over 10 bp from the nadir seen last week. This comes with four out of five companies in the S&P 500 who have reported earnings so far having beaten expectations, and with many base metal prices having yesterday printed new trend highs, with copper, for instance, hitting a 10-year high. All eyes will be on the Fed at the conclusion of its FOMC meeting later today. There has been some speculation the he might start to hint that the Fed could start to think about tapering after the BoC trimmed its asset purchases following its policy meeting last week. The reception of the U.S. Treasury's auctions of 2-, 5- and 7-year notes this week were tepid, though at least the 7-year sale wasn't as bad as the one of the same maturity back in February, which had been the catalyst for the sharp sell-off in both Treasuries and global sovereign bond markets in Q1. We expect policymakers will continue to refrain from hinting that they are starting to think about at tapering, and Chair Powell can be expected to once again emphasize there is a long way to go until the labour market returns to its pre-pandemic levels. But, given the strength in the recovery and the record trillions of dollars in fiscal stimulus, alongside the evident success in Covid vaccination programs in countries that have advanced rollouts, there is a reasonable chance that markets will want to price in some level of risk that the Fed may be forced to change its tune sooner than it has been signalling (ie the Fed's guidance for a first tightening in 2024 will start to look less and less credible). Also worth noting with regard to ongoing pandemic concerns, particularly the situation in India, is that the death rate per million of people there remains a fraction of what the UK experienced in January, while lab tests in India have found that existing vaccines still offer a good degree of protection against the new variant there. Global vaccine production capacity is ramping up, month by month, so there remain good grounds for optimism.

    [EUR, USD]
    EUR-USD has tipped lower amid a rebound in the dollar, which has been concurrent with longer-dated Treasury yields lifting by their greatest extent in a month. The Fed's evident success in turning around the inflation risk narrative, by stressing that the economy was a long way from full capacity, paid dividends in terms of taming bond vigilantes. The Treasury market was perhaps ripe for a rebound in April after putting in its worst quarterly performance in 34 years in Q1. But, with the U.S. economy building up a head of steam on the back of the Covid vaccine rollout, alongside the release of pent-up consumer demand and outsized record-level of fiscal stimulus, and with a central bank that remains steadfastly in uber-accommodative mode, the risks for inflation are to the upside. We have been noting that the upward trajectory for U.S. price increases into 2021 extends beyond the "base effects" that are clearly lifting the y/y measures. In April we expect CPI gains of 0.2% for both the headline and core. The y/y CPI gain should surge to 3.6% from 2.6%, while the y/y core price gain should climb to 2.2% from 1.6%. We expect y/y CPI gains to extend in May of around 3.8% for the headline and around 2.5% for the core. The recent weakness in the dollar will add upside risk to inflation, which in turn should help set the stage for a rebound in the U.S. currency. In sum, a rising bias in longer-dated U.S. yields is likely to re-establish as markets return to pricing in contingency risk that the Fed may be forced to tighten much sooner than the 2024 start point for tightening that it has been signalling. As for the euro, peak pessimism about the Covid situation looks to have passed, and Eurozone growth and inflation are set to rise, but lag the U.S. The ECB left policy settings unchanged last week while signalling an unambiguously dovish bias and kicking the decision on whether to extend the PEPP (Pandemic Emergency Purchase Program) down the road. We continue to anticipate that the directional bias of EUR-USD will shift back to the downside before long.

    [USD, JPY]
    USD-JPY has scaled back above the 109.00 level for the first time in two weeks, printed a one-week high at 108.39, The BoJ yesterday trimmed inflation forecasts, though the dominant driver has been the 10bp-plus rise in the U.S. 10-year yield from last week's lows. In data, Japan March inflation numbers, released last Friday, showed core CPI lifting to a y/y rate of -0.1% from -0.4%. As for USD-JPY, we remain bullish in the bigger picture, anticipating a renewed phase of rising U.S. yields in the months ahead.

    [GBP, USD]
    The pound has softened against the dollar while perking up against the euro and other currencies, reversing the recent pattern. Cable has ebbed back under 1.3900, but remains comfortably above the eight-day low seen last week at 1.3823. Sterling has over the last month underperformed the currencies we track (being the G10 units plus several others), aside from the case against the dollar, but still registers as an outperformer on the year-to-date, with only the oil-correlating Canadian dollar and Norwegian krone having risen by a greater extent than the UK currency. We retain a bullish view on the pound against the euro, and more especially the low-yielding currencies of surplus economies, such as Japan and Switzerland, which is hinged on the expectation that the global pandemic recovery trade will continue into 2022. The UK's main equity indices are replete with globally-focused cyclical stocks, which should benefit as major economies rebound. The broad trade-weighted value of the pound still remains near historically weak levels, too. These factors will have to offset any erosion in UK productivity and investment that may become apparent as a consequence of Brexit. UK local elections in early May will warrant monitoring, particularly with regard to how the pro-independence parties fare, and whether they can reach a supermajority in the Scottish parliament. This would legitimise their calls for another independence referendum, though polls have been tipping out of their favour lately. It's a close call: Politico's poll-of-polls tracker currently shows 46% favour remaining in the UK with 45% favouring an exit, with the remaining 9% undecided.

    [USD, CHF]
    Policymakers at the SNB retain a chronic disquietude about the franc's value. Unlike most central banks, the SNB explicitly incorporates the franc into monetary policy to ward off speculative purchases of the currency, which would impart deflationary forces (via cheaper imports) with the consequential impact of an unwelcome tightening in real interest rates. The central bank repeated at its latest quarterly monetary policy review that the franc remains "highly valued" and said it is ready to intervene directly in the foreign exchange market.

    [USD, CAD]
    USD-CAD has continued a consolidation of recent losses at levels moderately above the six-week low that was seen on Monday at 1.2382. The pair has remained heavy since the BoC surprised this week by trimming QE purchases to $3 bln per week from 4 bln, with policymakers bringing forward their forecast for a return to full capacity growth to the second half of 2022 from 2023. Oil prices will remain, as always, a key determinant of the Canadian dollar's value. Crude prices have come off the one-week highs that were seen yesterday as markets digest the OPEC+ group's decision to lift output quotas in May, which it did on the back of an anticipated rise in demand out of major economies. The evident success in Covid vaccination programs in countries that have advanced rollouts has encouraged bullish demand forecasts for oil. With regard to ongoing pandemic concerns, particularly the situation in India (which is the world's third biggest importer of oil), is that the death rate per million of people there remains a fraction of what the UK experienced in January, while lab tests in India have found that existing vaccines still offer a good degree of protection against the new variant there. Global vaccine production capacity is ramping up, month by month, so there remain good grounds for optimism.

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