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By XE Market Analysis February 12, 2021 4:07 am
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    XE Market Analysis: Europe - Feb 12, 2021

    The dollar has firmed up amid a risk-wary sentiment in global markets, which has seen world equity markets settle lower from record highs. At the same time, market conditions have been thinned by the lunar new year holidays in China and some other Asian nations. Some tough talk aimed at China from U.S. President Biden was blamed by some on the souring in sentiment, alongside a higher than expected print in weekly U.S. unemployment claims data. The DXY dollar index, after tumbling in three of the last four days, found a footing and lifted to a three-day high at 90.53. The index has been trading without sustained direction for nearly two months now, having recovered out of the 35-month low that was seen in early January at 89.21. EUR-USD settled deeper in the lower 1.2100s, edging out a two-day low at 1.2110, while USD-JPY pegged a three-day high at 104.98. Cable traded below 1.3800 for the first time since Tuesday. The dollar bloc currencies were marginal underperformers. Bigger picture, the reflation trade seems more likely to revive and sustain than not, given the precipitous decline in the rate of new positive Covid test outcomes worldwide (including South Africa, despite the supposed hyper-transmissibility of the dominant SARS-Cov2 variant there), vaccine rollout, stimulus, and prospects for a lockdown-saving fuelled consumer spending spree in developed economies as and when societal restrictions are lifted. This translates as a weaker dollar call, which remains richly valued by historical trade-weighted standards. Elsewhere, Bitcoin hit yet another record high earlier, this time at $48,540, after BNY Mellon said it will offer custodian services for cryptocurrencies. Some crypto devotees are calling for Bitcoin to reach $500,000, anticipating a long-awaited embrace by institutional investors. Others think there is a risk that Bitcoin is little more than a passing fad. A recent UBS research note argued that "there is little to stop a cryptocurrency's price from going to zero when a better designed version is launched or if regulatory changes stifle sentiment," pointing to the analogy of Netscape and Myspace as "...examples of network applications at that enjoyed widespread popularity but eventually disappeared."

    [EUR, USD]
    EUR-USD settled deeper in the lower 1.2100s, edging out a two-day low at 1.2110. The U.S. currency has found a footing after recently weakening, concomitantly with the rearing back of the reflation trade. Tesla's decision to shift of $1.5 bln into Bitcoin this week was another factor that has weighed on the greenback. While the euro may strengthen further, we don't anticipate the common currency to be the long of choice in a softening dollar environment, at least for now, given the EU's laggard progress in rolling out Covid vaccinations means that continental Europe will likely lag peers in reducing societal restrictions. We still remain bullish on EUR-USD in the medium- to-longer-term view, however, which hinges on our view for the reflation trade to sustain over the coming weeks and months. The dollar is richly valued by the measure of the broad real effective exchange rate. Amid this context, the Fed is committed to an inflation tolerant, lower-for-longer policy posture, which is in essence a pro soft-dollar policy given the implication for declining real interest rates. The idea here, with regard to exchange rate determination, is that the Fed may have more luck in stimulating inflationary pressures than the ECB. This would in turn put further downward pressure on the U.S. real interest rate compared to the Eurozone.

    [USD, JPY]
    USD-JPY has lifted towards 105.00, putting in some distance from the two-week low seen on Wednesday at 104.41. Recent declines have been driven by broad dollar weakness. At play this week have been Tesla's decision to park $1.5 bln in Bitcoin, which seemed to spark declines in the U.S. currency, alongside a drop from highs in U.S. Treasury yields, a strong rekindling in the global reflation trade amid tumbling positive Covid tests worldwide and vaccination optimism (concerns about new variants being offset by hopes for an effective response by tweaking existing vaccines). The flagship indices on Wall Street hit record highs this week, and global markets have been buoyant. Base metals and oil prices have also been rising. The BoJ last month left the main monetary policy settings unchanged. The deadlines for some funding programs were extended, with the central bank taking a grimmer view on the current state of the economy, although it also upped its growth forecast for the expected recovery in the next fiscal year. The BoJ has more recently been fretting about the possible side effects from its expansionary policy, and flagged a review and possible recalibration of measures at the March meeting in order to improve efficiency.

    [GBP, USD]
    Cable traded below 1.3800 for the first time since Tuesday amid a rebound in the dollar. Taking a step back, sterling is showing about a net gain of about 1.7% on the year-to-date (i.e. since the UK left the EU's common market and customs union) when averaged against the dollar, euro and yen, and is showing modest gains versus the Australian dollar and other dollar bloc currencies over this time, too. This is despite the inevitable rise in friction that Brexit has brought to trading relationship between the UK and EU. Bullish considerations have been offsetting, including the passing of over four years of Brexit uncertainty, which should lead to a revival in business investment; the UK's ahead-of-the-pack Covid vaccination program, which should enable the government to make a start on derestricting the economy before some peers, particularly the EU, and the BoE's recent signalling that has laid to rest any lingering expectations that the negative interest rate option would likely be implemented in the UK. The domestic data calendar picks up tomorrow, with the release of of Q4 and December GDP data, along with December production and trade data, though these seem particularly backward looking given the focus on exiting from Covid-related lockdowns.

    [USD, CHF]
    Policymakers at the SNB retain a 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 repeated at its latest quarterly monetary policy review that the franc remains "highly valued" and said it is ready to intervene directly in the foreign exchange market.

    [USD, CAD]
    USD-CAD has rallied into three-day high territory above 1.2750, partly on a rebound in the greenback and partly as the Canadian dollar, and other commodity-correlating currencies, underperform. Market sentiment has turned risk cautious, leaving global equity markets settling off record highs. Oil prices are softer. Front-month WTI futures dropped over 1% to a three-day lows under $57.50, correcting from the one-year high that was seen on Wednesday at $58.91. Oil had been underpinned by a variety of factors, ranging from demand-stimulating cold weather in Europe, to the large inventory draw in weekly U.S. data last week, to continuing OPEC+ supply constraint (Saudi Arabia last week commenced a unilateral supply cut that will last through to the end of March), to dropping positive Covid tests worldwide and vaccine optimism, and to the approaching mega-stimulus spending program in the U.S. economy. We have been noting downside risks to the oil market ahead, however, given the juxtaposition of prices having returned far into pre-pandemic ranges and with global oil demand not likely to return to pre-pandemic levels for a considerable time yet.

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