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By XE Market Analysis December 8, 2020 4:20 am
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    XE Market Analysis: Europe - Dec 08, 2020

    Sterling has traded softer on Brexit anxiety, but not dramatically so and the currency has remained above lows seen yesterday against the dollar, euro and other currencies. Dollar pairings and cross rates have outside the involvement of the pound, remained directionally unvaried. Price action in global asset markets continued to reveal a level of risk wariness among investors. The Nasdaq 100 still closed at yet another record high, while the DJIA and S&P 500 posted moderate declines. The Nasdaq has become unrepresentative of broader stock markets, being dominated by FAANG and other cash rich stay-at-home enabling companies, and where value is based on expected future earnings potential. Some have recently been likening the Nasdaq index to a safe haven asset, although at the same time being both a bear and bull market play. Most equity markets across the Asia-Pacific region today have declined, by varying degrees, though most by a relatively moderate extent. European index futures are down moderately, as are DJIA and S&P 500 futures. Market narratives are ascribing the risk-wary tone as being a consequence of rising positive Covid tests across northern hemisphere nations, and the associated doubling down of containment measures, along with the logistical challenges of the vaccine program. The time of the year, December, along with the recent depletion in global fund manager cash (as highlighted by the latest BoA fund manager survey), are other factors. SeintimenTraders SMI -- smart money index -- which attempts to gauge the attitudes of hedge funds and other fund managers, is nearing its lowest levels of the year. As for the dollar, the risk-cautious backdrop has had the effect of taking the steam out of the currency's down trend. For those bullish on global equities and bearish on the dollar, a level of tactical hedging might be warranted to cover the year-end period. As for the pound, the Brexit excruciating endgame is unfolding. UK PM Johnson offered a concession to the EU, to remove the offending elements of the controversial internal markets bill, which was likely his intention all along. Johnson will be in Brussels "in the coming days" for face-to-face meetings. We continue to expect a deal, though the risks of no-deal seem palpable, with France maintaining a more hawkish stance on fishing than many anticipated. There have been reports that fishing is a sideshow, being used by the EU to pressure the UK. The real issue is governance and an appeal process, with the EU's demands the UK sees as undermining its sovereignty.

    [EUR, USD]
    EUR-USD has seen some whippy price action over the last day, gravitating around the 1.2100 level. This marks a pause in the bull trend that left a 32-month peak at 1.2177 last Friday. The pair rallied by over 1.5% last 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 last 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, translating 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 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 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 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 over the medium- to longer-term.

    [USD, JPY]
    USD-JPY has remained directionally limited, holding near the 104.00 level. Yen crosses have lost upside traction, and many have dipped amid a risk-wary sentiment in global markets. Lofty valuations in asset markets, along with a winding down in commitment into year end have whittled on the previously strongly bullish sentiment. Regarding USD-JPY specifically, both currencies are 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, although this may not resume until the near year. 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]
    Sterling has traded softer on Brexit anxiety, but not dramatically so and the currency has remained above lows seen yesterday against the dollar, euro and other currencies. The Brexit excruciating endgame continues to unfold. UK PM Johnson offered a concession to the EU, to remove the offending elements of the controversial internal markets bill, which was likely his intention all along. Johnson will be in Brussels "in the coming days" for face-to-face meetings. We continue to expect a deal, though the risks of no-deal seem palpable, with France maintaining a more hawkish stance on fishing than many anticipated. There have been reports that fishing is a sideshow, being used by the EU to pressure the UK. The real issue is governance and an appeal process, with the EU's demands the UK sees as undermining its sovereignty. There are strong of win-win incentives for both sides to reach an accord, even if only a narrowly based one.

    [USD, CHF]
    EUR-CHF has settled around 1.0800 after failing to sustain recent gains above 1.0850. Recent risk-on positioning had 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 their 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 found a footing, and may be in for a relatively sustained rebound after posting a 26-month low at 1.2770 on Monday. Oil prices have softened after reaching a nine-month peak on Friday, and there may be more to go in this theme. While the bigger picture prospects remain bullish for oil and oil-correlating currencies, such as the Canadian dollar, the nearer term looks more challenging. Oil supply is on the up, with Libyan supply going back to pre-blockade levels, Norway having announced a rise in output from year-end, and the OPEC+ group having announced a 500k barrels per day increase from January. There are also signs that OPEC dissent is increasing, as highlighted by a Chatham House last week, with multiple participants in the output quotas unwilling to comply any longer. There is also expectations that U.S. president-elect Biden will reduce will lift sanctions on Tehran, which would see Iranian output increase. All this comes amid increasing Covid-related restrictions across North America, and with Europe is maintaining restrictions. While Covid vaccination programs have started in Russia and the UK, and in the U.S. as soon as next week, these won't have much impact in alleviating restrictions over the northern hemisphere winter. The scene looks to be set for a near-term correction in oil prices, which would see USD-CAD's directional bias shift from the downside to the upside for a period.

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