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By XE Market Analysis December 10, 2020 3:52 am
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    XE Market Analysis: Europe - Dec 10, 2020

    Sterling is under pressure after three hours of "lively and interesting" talks between UK PM Johnson and the European Commission President von der Leyen, and their chief negotiators, last night failed to find a way round "significant obstacles." Talks will continue, and a new deadline has been set for Sunday, with the leaders promising that a "firm decision" would be made then. UK foreign secretary Raab said that talks could still be extended beyond then. Either Johnson will have to decide whether the disruption of a no-deal is worth the risk, and/or von der Leyen will have to persuade EU leaders to budge during the group's leaders' summit today and tomorrow. The BBC's Europe editor Katya Alder reported that EU diplomats are ready to go an extra mile, but contrary to the UK government view, the EU thinks the ultimate decision for deal or no deal lies primarily with the UK. Our hunch is that a deal will still be reached, though Johnson will need some concessions from the EU as he will have to sell any deal to the influential faction of Brexit ideologues in his party. The EU's demands on fishing access to UK waters and governance, and in particular retaliatory measures if the UK diverged from EU rules, are on terms that Johnson singled out yesterday, just ahead of his trip to Brussels, that "no prime minister could accept." He has some wiggle room, as he could argue that leaving the EU in some alignment of its rules is the pragmatic option in the Covid era, and that the UK could diverge from EU rules over time. A no-deal scenario would not come without potentially significant political risks to Johnson, and would see Scotland's SNP step up demands for an independence referendum. The European Commission said it will publish "very narrow" no-deal contingency plans to maintain aviation and functioning borders. The pound has dropped over 0.5% against the dollar in falling to the lower 1.3300s, and has seen a similar magnitude of decline against the euro and other currencies. The DXY dollar index edged out a three-day high at 91.09, aided by the pound's weakness, while EUR-USD has lifted moderately after posting an eight-day low at 1.2059 yesterday. Elsewhere, the Australian dollar has remained perky, posting a new three-month against the yen, and nearing the 29-month high seen against the U.S. dollar yesterday.

    [EUR, USD]
    EUR-USD has settled at lower levels amid a pause in the bull trend that left a 32-month peak at 1.2177 last Friday. We assume markets will become more risk-cautious into the year-end period, which may see both the bull trend in global asset markets and the dollar's downtrend lose steam. We remain bullish on EUR-USD into 2021, however, on the proviso that global asset markets remain in a bull trend, which looks likely amid the mix of fiscal stimulus, a vaccine-assisted return toward societal and economic normalcy, an expected release of pent-up consumer demand in major economies, low interest rates, and so forth. In this scenario, the asymmetry between richly valued U.S. stock markets versus comparatively cheaply priced markets in Europe and across the emerging world will generate value-seeking capital outflows out of the dollar. The Fed's inflation tolerant policy rubric, which should keep U.S. real interest rates on a loosening path, is also also a dollar negative. Nearer term, the ECB will announce its latest "policy recalibration" today, which is almost certain to involve a strengthening of the PEPP and TLTRO programs along with a more symmetric inflation target, although anyone hoping for another easing bonanza are likely to be disappointed.

    [USD, JPY]
    USD-JPY has lifted to eight-day highs above 104.50. Japanese importers were reportedly buying dollars in Tokyo today, which is a "gotobi" date in Japan (a date multiple of five, around which financial transactions are grouped and settled in Japan). AUD-JPY and CAD-JPY, meanwhile, posted respective three- and six-month highs. Regarding USD-JPY specifically, both the dollar and the yen 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 see as a longer-term softening trend, especially against the cyclical currencies, including the dollar bloc, although this may not resume fully 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 is under pressure after three hours of "lively and interesting" talks between UK PM Johnson and the European Commission President von der Leyen, and their chief negotiators, last night failed to find a way round "significant obstacles." Talks will continue, and a new deadline has been set for Sunday, with the leaders promising that a "firm decision" would be made then. UK foreign secretary Raab said that talks could still be extended beyond then. Either Johnson will have to decide whether the disruption of a no-deal is worth the risk, and/or von der Leyen will have to persuade EU leaders to budge during the group's leaders' summit today and tomorrow. The BBC's Europe editor Katya Alder reported that EU diplomats are ready to go an extra mile, but contrary to the UK government view, the EU thinks the ultimate decision for deal or no deal lies primarily with the UK. Our hunch is that a deal will still be reached, though Johnson will need some concessions from the EU as he will have to sell any deal to the influential faction of Brexit ideologues in his party. The EU's demands on fishing access to UK waters and governance, and in particular retaliatory measures if the UK diverged from EU rules, are on terms that Johnson singled out yesterday, just ahead of his trip to Brussels, that "no prime minister could accept." He has some wiggle room, as he could argue that leaving the EU in some alignment of its rules is the pragmatic option in the Covid era, and that the UK could diverge from EU rules over time. A no-deal scenario would not come without potentially significant political risks to Johnson, and would see Scotland's SNP step up demands for an independence referendum. The European Commission said it will publish "very narrow" no-deal contingency plans to maintain aviation and functioning borders. The pound has dropped over 0.5% against the dollar in falling to the lower 1.3300s, and has seen a similar magnitude of decline against the euro and other currencies. In data, monthly GDP figures out of the UK for October came slightly above expectations, but still painted a picture of declining economic momentum, which has been unfolding since July.

    [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 remained heavy, failing to sustain gains above 1.2800 over the last day. The pair posted a 26-month low at 1.2765 on Tuesday. The Canadian dollar printed a new six-month high versus the yen. Oil prices are maintaining a consolidating phase after recent gains. We remain bearish on USD-CAD into 2021 on the expectation for an ongoing, strong rally in global asset markets amid a Covid vaccine-assisted return to something approaching societal and economic normalcy. But, there is a risk for a near-term positioning rebound in USD-CAD, heading into the Christmas and new year holiday period. 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 are 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.

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