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By XE Market Analysis December 2, 2020 4:42 am
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    XE Market Analysis: Europe - Dec 02, 2020

    The dollar and yen have remained soft versus most other currencies, although some caution emerged in global asset markets after a fresh rally yesterday. EUR-USD broke higher over the last day and today extended to a new 32-month high at 1.2089. Demand for euros was notable yesterday, and followed eurozone inflation data for November that came in below expectations in posting a fourth consecutive month of deflationary CPI readings, at -0.3% y/y. This marks a tightening in real eurozone interest rates, which contrasts to the pronounced negative real interest rate picture in the U.S. as a consequence of diverging inflationary pictures in the eurozone versus U.S. The last U.S. CPI headline for October was 1.2% y/y. In a zero percent interest rate world, this apparently matters in exchange rate determination, which may explain why markets discarded the 7bp-plus widening in the U.S. 10-year yield versus the 10-year Bund yield yesterday. The market is factoring that recession-bound eurozone economies will maintain disinflationary pressures. The Fed's inflation tolerant, lower-for-longer policy emphasis, along with the marked outperformance in European stock markets relative to global peers over the last month are other considerations at play, with European assets seen offering greater value opportunities in the vaccine-assisted view for a post-Covid return to economic normalcy. The euro gained on the pound, while the UK currency gained on the dollar and yen. Market participants continue to take a sanguine view of the Brexit endgame, despite the ongoing lack of a breakthrough in trade negotiations. The yen, meanwhile, remained in the underperforming lane of currencies. USD-JPY was buoyant, rising above 104.50 and bumping up on Tuesday's 104.58 high, while EUR-JPY saw a fresh 12-week high and AUD-JPY posted a two-and-a-half month peak. In stock markets, South Korea's KOPSI hit a new record high, and Japan's Nikkei posted a new 29-year high, though the MSCI Asia-Pacific index, while buoyant, remained below the record high that was seen last week. Commodities traded steady-to-softer, though aluminium prices saw a fresh two-year high. U.S. and European equity futures declined modestly. Australia's Q3 GDP provided the latest in a run of above-forecast global data, rising 3.3% q/q. This followed the record 7.0% q/q contraction in Q2, and best the median forecast for 2.6% growth while marking the best quarterly growth rate since 1976.

    [EUR, USD]
    EUR-USD extended to a new 32-month high at 1.2089. Demand for euros was notable yesterday, which followed eurozone inflation data for November that came in below expectations in posting a fourth consecutive month of deflationary CPI readings, at -0.3% y/y. This marks a tightening in real eurozone interest rates, which contrasts to the pronounced negative real interest rate picture in the U.S. as a consequence of diverging inflationary pictures in the eurozone versus U.S. The last U.S. CPI headline for October was 1.2% y/y. In a zero percent interest rate world, this apparently matters in exchange rate determination, which may explain why the market discarded the 7bp-plus widening in the U.S. 10-year yield versus the 10-year Bund yield yesterday. The market is factoring that recession-bound eurozone economies will maintain disinflationary pressures, with the ironic consequence of causing euro appreciation against the dollar, despite the disadvantageous growth differential between the eurozone and the U.S. There are other factors at work, one being the search for value in global markets as uncertainties dissipate (the two central ones being the clearing U.S. political picture, which is raising the prospect for new fiscal stimulus, along with the rapid progress in Covid vaccines), which are a dollar negative, especially with the FAANG stocks shifting to massive outperformers to underperformers. The Fed's inflation tolerant, lower-for-longer policy emphasis, along with the marked outperformance in European stock markets relative to global peers over the last month are other considerations, with European assets seen offering greater value opportunities in the vaccine-assisted view for a post-Covid return to economic normalcy. We retain a bullish view of EUR-USD.

    [USD, JPY]
    The yen has remained in the underperforming lane of currencies. USD-JPY has remained buoyant, rising above 104.50 and bumping up on Tuesday's 104.58 high, while EUR-JPY has seen a fresh 12-week high and AUD-JPY has posted a two-and-a-half month peak. This fits the yen's inverse correlative pattern with global asset market direction. In stock markets today, South Korea's KOPSI hit a new record high, and Japan's Nikkei posted a new 29-year high, although the MSCI Asia-Pacific index, while buoyant, remained below the record high that was seen last week. Commodities traded steady-to-softer, though aluminium prices saw a fresh two-year high. U.S. and European equity futures declined modestly. Australia's Q3 GDP provided the latest in a run of above-forecast global data, rising 3.3% q/q. This followed the record 7.0% q/q contraction in Q2, and best the median forecast for 2.6% growth while marking the best quarterly growth rate since 1976. Regarding USD-JPY specifically, both currencies are viewed as safe haven, counter-cyclical currencies, which limits the direction scope for the pairing, though the real interest rate differential between the U.S. and Japan is a mathematical negative for the nominal exchange rate. Outside the case against the dollar, the yen is amid what we are tagging as a longer-term softening trend, especially against the cyclical currencies, including the dollar bloc. The yen's broader performance should continue to derive from the level of risk appetite in global markets. Japan's surplus economy, where yield-seeking domestic investors are apt to invest in foreign assets during times of confidence, but repatriate funds when times are uncertain, has established the yen as a low-beta haven currency.

    [GBP, USD]
    The pound has continued to traded relatively neutrally, and continues to show gains from month-ago levels against the dollar, euro and yen, among other currencies. Many market participants are in a state of non-commitment, waiting on concrete developments from the ongoing, down-to-the-wire negotiations between the EU and the UK. Yesterday had last week been touted as the deadline in EU-UK talks, but now the latest deadline is reportedly this Saturday, while there have been reports that the European parliament could convene as late as December 28 to ratify a trade deal. Germany's Merkel has been putting the pressure on EU states to compromise. Despite the negotiations dragging on, market participants are so far refraining from pricing in a no-deal outcome, as evidenced by the stability of the pound. Some political pundits have been arguing that there is a risk that the only way forward may be a no-deal -- which in the event would in effect mean that a deal is delayed, albeit at the price of near-term logistical chaos and with what the OECD warned yesterday would entail a "serious" economic hit. What is clear, deal or no deal, is that EU and UK's relationship will be an ever evolving and complicated one when the UK exits its transition membership of the common market and customs union at year end. The UK wants to diverge from EU rules, while EU states are concerned that the UK will undercut their markets. The relationship will be subject to dispute arbitration with the possibility of retributive measures. This is why markets are anticipating only a narrow free trade deal, which would be centred on manufacturing.

    [USD, CHF]
    EUR-CHF rallied to three-month highs above 1.0850, extending recent gains from sub-1.0700 levels. Recent risk-on positioning has been weighing on the Swiss franc with investors factoring in a sea change in optimism about a vaccine solution to the Covid-19 crisis. This will be pleasing to policymakers at the SNB, given it 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 stated at its last quarterly monetary policy review that the franc remains "highly valued" and said it is ready to "intervene more strongly in the foreign exchange market."

    [USD, CAD]
    USD-CAD has posted a new 26-month low at 1.2914. The Canadian dollar has also rebounded out of a one-month low against the euro, which has been bid over the last day following the upside breakout in EUR-USD. Oil prices have lifted today after softening in recent sessions, with non-OPEC Norway announcing that it will end self-imposed output restrictions at year end, while a Reuters article citing sources said that some members of the OPEC+ group are itching to lift output levels. The group on Monday delayed a decision on quotas for three days (until tomorrow). Notwithstanding the Reuters report, the market consensus is for the group to maintain prevailing quotas for another three months from January. A six-month extension is also being considered, reportedly, which by OPEC's analysis would likely swing the oil market back into supply deficit in 2021. Global stockpiles are high and demand for oil is set to be well below normal through the northern hemisphere winter due to Covid countermeasures, which are already tight in Europe and becoming more restrictive across North America and in the more northerly Asian countries. At the same time OPEC output has increased, with Libyan production having fully returned to pre-blockade levels. There is also a view that after the Covid pandemic has gone, oil will have a more elastic characteristic, with many developed nations likely to see a higher prevalence of working from home than before, reducing demand for fuel and enabling consumers of gasoline to reduce commuting days during times of oil high prices. These are motivating reasons for oil producing nations to keep supply restrained. Assuming quota discipline is maintained, the outlook is bullish for oil on the back of the increased optimism for a vaccine-assisted route out of the prevailing Covid situation. Consumers have built up savings and there is potential for a significant acceleration in global economic activity by mid next year. USD-CAD has been trending lower since March, and we anticipate there is more to come.

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