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By XE Market Analysis February 18, 2021 4:44 am
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    XE Market Analysis: Europe - Feb 18, 2021

    Both the dollar and U.S. Treasury yields have settled off their respective highs, while global equity markets have come off the boil as investors take stock in the face of lofty valuations. The reflation trade remained alive and kicking in commodities, however, with copper and other base metals surging to fresh multi-year highs, buoyed by demand on Chinese exchanges, which reopened after their week long hiatus for the lunar new year holiday. Oil prices also clocked a new 13-month peak. A Reuters article highlighted a laboratory study showing that the Pfizer vaccine was less effective against the South African variant of SARS-Cov2, which may have been a contributory factor behind the more risk-cautious sentiment in stock markets, although evidently this story had little impact in the commodity realm. Some scientists have been welcoming the similarities in the various 'successful' mutations of the coronavirus -- that is the those variants that become dominant out of the thousands of mutations -- as it suggests that the only way the virus is successfully mutating is to a more transmissible versions, as seen the South African, Brazilian and UK variants, rather than to a more deadly version of itself. There is also confidence that existing vaccines can also be relatively easily tweaked to deal these variants, too. In currency markets today, ranges have been narrow so far. The DXY dollar index has seen less than a 10 pip range, holding just below the 91.00 level. EUR-USD has been similarly unambitious in directional terms, plying a narrow path above yesterday's 10-day low at 1.2023. A modicum of yen outperformance has seen USD-JPY ebb to a two-day low at 105.69. The pair remains up by just over 2.5% on the year-to-date, corresponding with the pronounced widening in U.S. Treasury over JGB yield differentials, which in the case of the 10-year benchmarks has been more than 35bp over this period. Yen crosses, which have recently been trading at either multi-month or multi-year highs, also tipped lower. In the cryptocurrency realm, Bitcoin rallied to yet another record, this time above $52,500, amid increasing signs that the asset class, which is essentially a digital version of a precious metal (limited supply and no yield, although with the added benefit of no storage costs), is becoming accepted by institutional investors.

    [EUR, USD]
    EUR-USD has settled to plying a narrow path above yesterday's 10-day low at 1.2023. This comes with both the dollar and U.S. Treasury yields settling off their respective highs, and with global equity markets having come off the boil as investors take stock in the face of lofty valuations. The dollar recently re-established a correlative link with Treasury yields, and specifically the differentials between Bund yields and other peers. The magnitude of the recent sharp spike in U.S. yields become too much to ignore for market participants, even allowing for the relatively high inflation rate in the U.S. relative to the Eurozone and other peers (which has a depressing effect on real yield differentials). The 10-year T-note yield printed highs above 1.30% earlier in the week, which is nearly 40 bp up on the prevailing yield at the end of 2020. The upcoming massive $1.9 tln fiscal spending spree in the U.S. is naturally causing markets to consider inflationary consequences and the associated possibility of the Fed being forced to tighten policy sooner than is generally being considered, despite the Fed's pledge to let inflation run higher in this cycle than it would have normally done. The FOMC minutes to the January 26-27 meeting, released yesterday, highlighted what we've known from that policy statement, that the Fed will remain in ultra accommodative mode given worries over downside economic risks and willingness to look beyond inflation spikes. But, hotter than expected data on retail sales, production, and PPI, and the likes of Goldman Sachs rising their U.S. GDP forecasts, the question is how long the Fed can continue with its new policy rubric, especially when the stimulus starts impacting, the economy reopens as the Covid vaccination program takes effect, and as and when consumers unleash some of their lockdown savings. As for the Eurozone, societal reopening may lag the U.S. and UK due to slow rollout of Covid vaccines. Overall, this presents a bearish backdrop for EUR-USD.

    [USD, JPY]
    A modicum of yen outperformance, which has come against the backdrop of sputtering global stock markets, has seen USD-JPY ebb to a two-day low at 105.69. The pair still remains up by just over 2.5% on the year-to-date, corresponding with the pronounced widening in U.S. Treasury over JGB yield differentials, which in the case of the 10-year benchmarks has been more than 35bp over this period. Yen crosses, which have recently been trading at either multi-month or multi-year highs, also tipped lower.

    [GBP, USD]
    Cable has recouped to levels above 1.3900 after trading under 1.3850 yesterday. The 34-month peak seen on Tuesday is at 1.3951. At the same time, the pound has posted a fresh 10-month high against the euro, and as lifted against the yen and other currencies. This continues the moderate outperforming bias the pound has been exhibiting on the year so far, when the UK completed Brexit by leaving its transition membership of the EU's common market and customs union. News earlier this week that the UK government reached, ahead of schedule, its target to vaccinate the most vulnerable groups to Covid have given markets reason to be bullish on sterling, 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. Prime Minister Johnson will be laying out a road map for reopening next Monday. This should keep the pound broadly underpinned.

    [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 is softer today after rallying over the prior two days. Fresh 13-month highs in oil prices, alongside a rally in many base metals to new multi-year highs, has returned some support to the Canadian dollar, which lost ground to the greenback lately due to a widening in the U.S. over Canadian yield differential. Front-month WTI oil futures pegged a new 13-month high at $62.67. The abnormal big freeze in central-southern U.S. has temporarily closed a significant part of the country's oil and gas operations, while increasing power demand, which has contributed to keeping oil prices underpinned. 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 -- which is hinged on 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 somewhat sceptical of this viewpoint. Nearer term (beyond the big freeze in the U.S. and assuming the Yemeni civil war doesn't curtail Mideast supply), it will be a question of sharply rising U.S. supply and weakening quota discipline among OPEC+ nations, alongside the fact that it may take a considerable time yet before global demand will be restored to 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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