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By XE Market Analysis December 4, 2020 4:45 am
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    XE Market Analysis: Europe - Dec 04, 2020

    Currencies have settled in relatively narrow ranges so far today, with the dollar and yen consolidating recent sharp declines. Global asset markets have remained buoyed, though mixed. The main U.S. equity indices hit fresh highs yesterday and copper prices today posted new near-seven-year highs today in Asia trading. South Korea's KOPSI pegged a new record peak, though the main equity indices in China, Japan and Australia remained off recent highs. U.S. equity futures also showed moderate gains. JP Morgan analysts said emerging market stocks are "under owned", forecasting a 20% rally, while Paul Tudor Jones forecast an "absolute, supersonic boom" in the U.S. economy in Q2 and Q3 next year due to unprecedented fiscal stimulus and a release of pent up consumer demand, on the proviso that Covid vaccine program proves effective. Today's release of U.S. November payroll, meanwhile, is expected to remind us of the grimmer realities of the now, with job growth expected to be the slowest in six months due to tightening Covid-related restrictions and the extended delay in another fiscal relief package. In Europe, German manufacturing orders came in much stronger than expected, underpinned by strength in export markets, including China. A major focus remains on Brexit. Tensions are scaling up in EU-UK negotiations, which if nothing else is a sure sign than they're very close to deadline, which is reportedly tomorrow. France, according to sources cited by media reports, has at the 11th hour increased demands on state aid rules, although an EU source cited by the BBC refuted this. It is also understood that Brussels has so far not accepted the UK's offer for EU fishing boats to keep 40% of the catch in UK seas. Sources on the UK negotiating team have also been cited in media saying that talks are near to collapse. Despite this, the pound, which is the principal conduit of investor expression on all things Brexit, has remained steady. Market participants are refusing to be draw in, having witnessed down-to-the-wire dramatics in previous Brexit negotiations, and waiting instead on concrete developments. We continue to expect a deal, though France is continuing to threaten it may veto

    [EUR, USD]
    EUR-USD has settled today after yesterday posting a 32-month peak at 1.2177. The pair has has rallied by over 1.5% this week despite a concurrent 6bp-plus widening in the U.S. T-note 10-year yield differential versus the 10-year Bund yield. One particular downward driver of the dollar came into sharp focus at EUR-USD's upside break on Monday, which seemed to be sparked by initial estimate for November eurozone inflation coming slightly below expectations, with CPI at -0.3% y/y. The relevance of this is that it contrasts the relatively high inflation rate in the U.S. (at 1.3% y/y in October), the implication being that inflation is imparting a loosening impact on real interest rates in the U.S., while deflation is imparting a tightening impact on real interest rates in the eurozone, which translates to higher nominal EUR-USD levels. The Fed's inflation tolerant, lower-for-longer policy rubric is a key consideration here, being conducive to dollar weakness. In a zero percent interest rate world, inflation differentials can matter in exchange rate determination, and explains why the market discarded the widening in yield spreads in the dollar's favour. The market is factoring that recession-bound eurozone economies will see continued 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. Insofar that a higher euro will curb eurozone growth potential, a self-reinforcing process can be observed, though this overstates realities. Inflation will jump in the eurozone once as and when negative y/y base effects drop out of the equation. Raw material prices have been surging, too, and there is potential for a strong rebound in Europe should Covid vaccination programs prove effective in Europe and globally. There are other factors behind dollar weakness at play, 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]
    USD-JPY has lifted back above 104.00 after posting a 16-day low yesterday at 103.67. The yen, meanwhile, has found a footing against most other currencies after recent sharp declines. Global asset markets have come off the boil, but still remain buoyant, overall. Regarding USD-JPY specifically, both currencies are viewed as safe haven, counter-cyclical currencies, which limits the directional 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 seen a mixed directional performance so far this week, showing gains on the dollar, but losses to the euro. A major focus remains on Brexit. Tensions are scaling up in EU-UK negotiations, which if nothing else is a sure sign than they're very close to deadline, which is reportedly tomorrow (although don't be surprised if it's not). France, according to sources cited by media reports, has at the 11th hour increased demands on state aid rules, although an EU source cited by the BBC refuted this. It is also understood that Brussels has so far not accepted the UK's offer for EU fishing boats to keep 40% of the catch in UK seas. Sources on the UK negotiating team have also been cited in media saying that talks are near to collapse. Despite this, the pound -- the principal conduit of investor expression on all things Brexit -- has remained steady. Irish foreign minister Coveney said yesterday that it is "very dangerous" to assume that if there is a no-deal outcome, that a deal would be reached during the first half of 2021, which appears to be a dig at the hawkish stance that France is taking. It has long been known that there are hawks in President Macron's administration who believe that it would better to negotiate with the UK "on the other side of a no-deal Brexit," on the view that the UK would then be much more pliable. Germany, and evidently Ireland, along with many other EU states, seem to be against this, so our view is that France will back down. Germany's Merkel has been putting pressure on EU states to compromise. The French have bad cop form on Brexit, having consistently threatened to veto the multiple extensions in last year's negotiation over the UK withdrawal agreement, only to back down with equal consistency. Macron has political reason to play it tough, with fishing a hot potato issue into presidential elections in 2022, but he also has strong realpolitik reasons to maintain good faith with both EU states and the UK. The pound's steadiness amid all this shows that market participants are refusing to be draw in, having witnessed down-to-the-wire dramatics in previous Brexit negotiations, and waiting instead on concrete developments. We continue to expect a deal.

    [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 posted a fresh 26-month low at 1.2845, which is now the current culmination of a down trend that's been prevailing since the March highs (when oil futures went sub zero). The pair has lost 12.5% over this period. Oil prices are up over 2% today (as of the early London morning) after the OPEC+ group finally reached an agreement on output quotas. This was something of a relief after the decision was extended from Monday, though the new agreement will see output increase by 500k barrels per day and covers just January, with OPEC+ ministers to meet monthly to review and tweak output. The crude market had been anticipating a three-month extension from January at prevailing quotas, though the new flexible approach has generally been taken as a positive given the unusual challenges being faced by oil producers. 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 and non-OPEC output has increased, with Libyan supply going back to pre-blockade levels and Norway having announced a rise in output. 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 big-picture 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. There is likely to be more to come in USD-CAD's downtrend.

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