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By XE Market Analysis August 28, 2020 3:11 am
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    XE Market Analysis: Europe - Aug 28, 2020

    The dollar has ebbed back toward the lows seen in the immediate wake of Fed Chair Powell's historic announcement of a shift in its monetary policy strategy, moving to an average inflation target. The narrow trade-weighted USD index (DXY) has receded to a 92.60 low, swinging the post-Powell low at 92.44 back into scope while extending the correction from yesterday's 93.30 rebound high. Though the Fed's shift was widely expected, the timing surprised. We and many others assumed it would be outlined at the September FOMC. Under the new regime, the Fed will let the economy run hotter and will let the inflation rate rise "moderately" over 2%. The announcement has caused some chop in markets, though has generally been supportive of stock markets (helping the laggard Dow index climbed into the green for the year) while longer dated sovereign yields in the U.S. and elsewhere have risen, with curves steepening. Inflation-adjusted U.S. Treasury yields have remained heavy, however, with the 5-year real constant maturity yield, for instance, indicated at -1.34% yesterday, which is fractionally above the -1.35% seven-year-plus low seen on the day before, so the new policy regime at the Fed is likely to maintain a dollar weakening bias. Elsewhere, USD-JPY scaled to a two-week high in Tokyo trading at 106.94 before correcting to a 106.29 low. The high reflected yen weakness, with EUR-JPY concurrently coming within a pip of the 16-month high that was seen in mid August, before the cross pulled back as the yen rebounded from lows. AUD-JPY also pegged a 16-month peak before turning lower. GBP-JPY saw a similar price action in posting a six-month peak before retreating somewhat. The relatively high beta dollar bloc currencies have been outperforming. AUD-USD has risen above 0.7300 for the first time since December 2018, while USD-CAD has printed a fresh seven-month low at 1.3085.

    [EUR, USD]
    EUR-USD has lifted back towards the 1.1899 high that was seen in the immediate wake of Fed Chair Powell's announcement of a shift in its monetary policy strategy, moving to an average inflation target. EUR-JPY, meanwhile, came within a pip of the 16-month high that was seen in mid August, before the cross pulled back as the yen rebounded from lows. The euro traded lower, however, against the pound and dollar bloc currencies. As for the Fed, the new framework regime means that the economy will be allowed to run hotter than hitherto, with the inflation rate allowed to rise "moderately" over 2%. The announcement caused some chop in markets, though has generally been supportive of stock markets (helping the laggard Dow index climbed into the green for the year) while longer dated sovereign yields in the U.S. and elsewhere have risen, with curves steepening. Inflation-adjusted U.S. Treasury yields have remained heavy, however, with the 5-year real constant maturity yield, for instance, indicated at -1.34% yesterday, which is fractionally above the -1.35% seven-year-plus low seen on the day before, so the new policy regime at the Fed is likely to maintain a dollar weakening bias. This should keep EUR-USD underpinned, though Wall Street's record breaking bull trend and recovering U.S. economy are providing offsetting forces.

    [USD, JPY]
    USD-JPY scaled to a two-week high in Tokyo trading at 106.94 before correcting to a 106.29 low. The high reflected yen weakness as the dollar held relatively steady against most other currencies. EUR-JPY came within a pip of the 16-month high that was seen in mid August, before pulling back as the yen rebounded from lows. AUD-JPY also pegged a 16-month peak before turning lower. GBP-JPY saw a similar price action in posting a six-month peak before retreating somewhat. The yen's declines were concomitant with gains in stock markets following the Fed's historic shift in its monetary policy strategy, moving to an average inflation target, though Wall Street saw profit taking late in the session yesterday, especially on hot tech stocks, and markets in Asia were mixed in choppy trading, though U.S. index futures have rallied by over 0.5%. In the bigger picture, most yen crosses have been trending higher since May, with the Japanese currency tracking inversely with global stock market direction. The yen is likely to remain apt to directional change on the back of shifting risk premia in global markets. Backed by a surplus economy, and one where yield-seeking domestic investors are apt to invest in foreign assets during times of confidence, but repatriate funds when times are uncertain, the yen has a profile of being a low-beta haven currency.

    [GBP, USD]
    Cable has seen some post-Fed announcement chop, but has remained underpinned by dollar weakness. The pair has today lifted back towards the eight-month high seen yesterday at 1.3283. GBP-JPY, meanwhile, printed a six-month peak today, before retreating somewhat as the yen rebounded from lows. EUR-GBP yesterday saw a two-month low at 0.8928, since settling around the 0.8950 mark. The recovery in both the domestic and global economy from the more extreme phase of lockdowns that were seen earlier in the year has been a positive for the UK currency, which had underperformed during the worst of the panic (the UK being a deficit nation with an open economy). Markets are also, for now, taking a sanguine view of the flop-out in last week's trade talks between the EU and UK. All things Brexit go down to the wire, and expectations for any real progress are low until much nearer the deadline, which is widely accepted as being the EU's leaders' summit in October. The consensus view is that a deal will be struck. We are wary. There are grounds to doubt there can be anything other than a narrow deal, given the intransigence on the EU's level-playing-field rules and fishing rights. A bear-bones deal or a no-deal outcome are a risk. Another risk is that the UK government's pandemic-era furlough scheme will end in late October, which is likely to cause an upward jolt to the unemployment rate, with the aviation, high street retail and hospitality sectors to be hard hit. The wage support scheme protected about 9.5 mln jobs at the height of the lockdown, though there remains up to 1.5 mln jobs at risk of being chopped in October, unless the government extends its support scheme (as Germany did with its plan yesterday).

    [USD, CHF]
    EUR-CHF has settled back to narrow range trading in the mid 1.0700s having failed to sustain gains seen last week, which produced a two-month high at 1.0853. The influence of the SNB's intervening hand may have been at play. Total Swiss sight deposits of francs have risen by 130 bln since the pandemic and consequential lockdowns took a grip on global markets back in March. Sight deposits can be viewed as a proxy marker of SNB intervention to sell francs in forex markets (after buying foreign currencies), which results in the crediting of newly created francs at commercial banks sight accounts. The rise in sight deposits also reflects SNB operations to boost liquidity via the COVID-19 refinancing facility. The advent of the EU's recovery fund, seen as a milestone by many analysts (a new liquid AAA fund that also reduces Eurozone breakup risks) has by many accounts caused a re-weighting of the common currency in portfolios, and which should help the SNB combat what it sees as a chronically overvalued franc. EUR-CHF still remains below the seven-month peak that was seen in early June at 1.0921.

    [USD, CAD]
    USD-CAD printed a fresh seven-month low at 1.3085 today. The Fed's policy framework regime shift, which translates as lower-for-longer with regard to interest rates, has weighed on the U.S. dollar while maintaining an overall risk-on sentiment in markets (notwithstanding some bouts of profit taking in some markets). In the bigger picture, USD-CAD has been trending lower since mid March. The global economic recovery from lockdowns, which were at their zenith in April, has been instrumental in driving this downtrend, while the U.S. currency waned as a safe haven unit before negative real U.S. yields subsequently become a dominant factor in fuelling the greenback's downtrend. Upside risks for USD-CAD include the OPEC+ group's course to easing output quotas, which could weigh on oil prices depending how it matches with the evolution in demand. The still unfolding coronavirus pandemic and geopolitical tensions also remain on the radar, should they derail the recovery in global asset markets.

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