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By XE Market Analysis February 16, 2021 4:11 am
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    XE Market Analysis: Europe - Feb 16, 2021

    The dollar and more especially the yen came under renewed pressure as the global reflation trade continued. The MSCI Asia-Pacific and U.S. index futures posted fresh highs, although sentiment subsequently weakened somewhat to push these markets off their highs on news that China is considering limits on rare earth mineral exports to the U.S. Such minerals are essential for the production of advanced weaponry, among other uses. This shift in mood also saw the dollar and yen lift out of their lows versus other currencies, though both still remained at modest net-lower levels on the day. The latest daily figure for new positive Covid test results globally hit the lowest number since last September, despite a higher level of testing between now and then, and is now nearly 70% down from the highest daily figure that was seen in early January. This, along with optimism for successful vaccination programs, and upcoming stimulus in the U.S. and EU, have been fuelling the reflation trade. This has pushed up U.S. Treasury yields, with the 10-year note yield earlier hitting a new 11-month high at 1.252%, though the dollar has broken its correlation with yields. EUR-USD tested last week's high at 1.2150, which is the loftiest level seen in 18 days. Cable posted a new 34-month high at 1.3951, while the pound also carved out a new nine- and 14-month highs against the euro and yen, respectively. USD-JPY lifted to an eight-day high at 105.64, drawing back in on the four-month peak that was seen earlier in the month at 105.78. The dollar bloc and other cyclical currencies remained buoyant. AUD-USD lifted above 0.7800 for the first time in a month while NZD-USD printed a six-week peak. USD-CAD posted a four-week low at 1.2608. NZD-JPY hit 23-month high, AUD-JPY a 14-month high and CAD-JPY a one-year high. Oil prices remained underpinned, although down on Monday's 13-month highs. Freak cold weather in Texas is seen as both lifting demand for power while threatening oil production and refining operations there. A flare up in the Yemeni civil war is also seen as a supportive influence.

    [EUR, USD]
    EUR-USD tested last week's high at 1.2150, which is the loftiest level seen in 18 days. The euro has also remained underpinned against the yen, though has seen fresh trend lows against the pound and remains weak versus the dollar bloc and other cyclical currencies. The dollar itself has been underperforming all but the Japanese yen amid reflation trade positioning, with the correlation with rising U.S. Treasury yields having broken down. The 'real' (inflation adjusted) constant maturity Treasury yields on both the 5- and 7-year maturities last week, for instance, hit fresh major trend lows of -1.86% and -1.46%, respectively, which helps explain the dollar's underperformance. This could change if nominal yields continued to rise and markets perceived that the Fed would be forced to tighten monetary policy earlier than prevailing expectations. We still remain bullish on EUR-USD in the medium- to-longer-term view, which hinges on our view for the global recovery 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]
    The yen came under renewed pressure as the global reflation trade continued. The MSCI Asia-Pacific and U.S. index futures posted fresh highs, although sentiment subsequently weakened somewhat to push these markets off their highs on news that China is considering limits on rare earth mineral exports to the U.S. Such minerals are essential for the production of advanced weaponry, among other uses. The latest daily figure for new positive Covid test results globally hit the lowest number since last September, despite a higher level of testing between now and then, and is now nearly 70% down from the highest daily figure that was seen in early January. This, along with optimism for successful vaccination programs, and upcoming stimulus in the U.S. and EU, have been fuelling the reflation trade. USD-JPY lifted to an eight-day high at 105.64, drawing back in on the four-month peak that was seen earlier in the month at 105.78. Yen crosses also gained, with the likes of EUR-JPY, GBP-JPY and AUD-JPY all posting fresh major trend highs. There was some dovish BoJ-speak in the mix today. BoJ Governor Kuroda said that there is no plan to end the purchase of ETF purchases or to permanently reduced purchases.

    [GBP, USD]
    Cable posted a new 34-month high at 1.3951, while the pound also carved out a new nine- and 14-month highs against the euro and yen, respectively. The UK currency has also been holding up against the buoyant dollar bloc currencies, and other cyclical units. News that the UK government reached, ahead of schedule, its target to vaccinate the most vulnerable groups to Covid have given markets reason to buy pounds, which is amid what could be described as a crawl out of historically weak trade-weighted valuations with four-and-a-half years of Brexit uncertainty having finally passed. Only Israel and UAE have vaccinated faster than the UK, and the contrast with the situation in the EU has been lately been mooted in market narratives as being a bearish factor for EUR-GBP. UK data calendar this week is highlighted by January inflation (Wednesday), where the median expectations is for headline CPI to ebb back to a 0.5% y/y rate. This would fit BoE projections, with the central bank anticipating a sharp rise back toward the 2% target over the coming months, when base effects (caused by the impact of last year's March-June lockdown) will drive y/y price comparisons higher. January retail sales are also due (Friday), where a 1% m/m contraction is expected.

    [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 posted a four-week low at 1.2608, while CAD-JPY hit a one-year high. The Canadian dollar also saw an 11-day high in the case against the euro. Oil prices remained underpinned, although down on Monday's 13-month highs. Crude prices are up over 23% on the year to date, which has strengthened the terms of trade position of the Canadian economy. The latest bullish influences on the crude market include freak cold weather in Texas, which is seen as both lifting demand for power while threatening oil production and refining operations there. A flare up in the Yemeni civil war has also been a supportive influence. Taking a step back, a bullish supply-gap hypothesis has become a fashionable view, which anticipates continued strong oi price gains as the reflation trade (the Covid vaccine assisted journey back towards economic normalcy) unfolds through 2021. JPM in a recent note, for instance, forecast an "epic systemic short squeeze" will unfold over the next month, while GS analysts recently mooted $150.0 as an upside target. We are sceptical of this viewpoint, however. Nearer term, it will be a question of sharply rising U.S. supply and weakening quota discipline among OPEC+ nations, alongside the fact that global demand may be some way from reaching pre-pandemic levels. Longer term, the oil industry is well positioned in terms of known and unexploited reserves, to respond to any sustained demand increases, while demand-quelling factors, such as the new trend for working from home, and increasingly available alternative electrically-powered transport, will also be in play.

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