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By XE Market Analysis January 11, 2021 4:28 am
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    XE Market Analysis: Europe - Jan 11, 2021

    The dollar has continued to rise, putting in more distance from the major-trend lows seen against the euro, yen, dollar bloc, and many other currencies a week ago. The U.S. currency has rallied on each trading day since the Georgia runoff elections, when it became clear that the Democrats would control the Senate. This has seen Treasury yields spike and growth expectations rise, given the implication for much greater fiscal spending than would have been the case under a Biden presidency constrained by a split Congress. It should be noted, too, that the combo of higher inflation and ultra-accommodative Fed policy (the ingredients for falling real interest rates) has weakened as dollar bearish argument, as Fed policy expectations, even under the central bank's new lower-for-longer rubric, may now be looking too dovish in context of the Democrat sweep. There is also a positional aspect to be dollar bullish, at least over the near term, given the accumulation of dollar short exposures over the last couple of months, and which may be trimmed further.
    The dollar's gain today has come despite a dip in Treasury yields, which in turn has been seen amid a pull back in most global equity markets and commodities, suggesting that the greenback is still being viewed as a safe haven by market participants. The DXY dollar index posted a 19-day high at 90.45, while EUR-USD printed a 17-day low at 1.2167. USD-JPY, a paring which has been particularly sensitive to the recent spike in U.S. yields, posted a one-month high at 104.22. The dollar block have lost over 0.5% to the dollar, as did Cable, which dropped to a 13-day low at 1.3483. Asian equity markets have mostly declined, while U.S. index futures have fallen by as mush as their cash versions rose during regular Wall Street trading on Friday. Oil prices are down from 11-month highs. Base metals are also down. Bitcoin and other crypto currencies have corrected sharply. In political situation in Washington DC remains calm, with President Trump having called (last week) for peace while affirming that there would be a smooth transition process. U.S. House leader Pelosi has set in motion a second impeachment trial of Trump, though Democrats are split on how hard to push for impeachment. Covid lockdowns and other forms of restrictions continue to tighten in many northern hemisphere countries, although vaccination programs and the prospect of spring (coronaviruses are highly seasonal in impact) should maintain investors conviction in the reflation trade.

    [EUR, USD]
    EUR-USD's correction has extended for a fourth consecutive trading day, this time posting a 17-day low at 1.2167. Markets have been still digesting the upcoming Biden administration with Democrat control of both the House and Senate. The Democrat sweep will see a rising budget deficit and an increased prospect for stronger growth. This can be chalked up as a dollar positive influence, with a consequent spike in U.S. Treasury yields improving the dollar's yield attractiveness relative to peers. A higher inflation curve has potential push down on real interest rates, though this would depend on the Fed sticking to its lower-for-longer policy rubric, which it may be less apt to do in context of the anticipated massive surge in fiscal expansion. Much of Europe, meanwhile, is in the tightest level of lockdowns since the 'mother lockdown' in spring last year, which threatens to put the region back in recession. Data out of Europe continue to show the manufacturing sector holding up, while the service sector takes a beating, bearing the brunt of Covid restrictions. The U.S. economy is also being negatively affected by Covid restrictions, though there is considerable variation in levels of response state by state. Overall, this backdrop, along with dollar-favourable shift in U.S. Treasury versus Bund yield differentials, has taken the wind out of the EUR-USD's uptrend. The pair had, early last week, clocked a 33-month high at 1.2350. For now, we anticipate that the prevailing bias will remain to the downside.

    [USD, JPY]
    USD-JPY posted a one-month high at 104.22. A spike in U.S. Treasury of JGB yield differentials as markets discount the Democrats clean sweep has been in the market mindset, with the dollar also rebounding across the board. Prospects for greater budget deficit fuelled growth also bodes well for the U.S. growth differential versus Japan and other economies. In Japan, the economy is heading back into contraction, as confirmed by the December PMI surveys, with key economic regions locking down in the face of rising positive Covid test results. Japanese policymakers will be welcoming of the yen's prevailing weakness, with USD-JPY's 100.00 level viewed as a line in the sand on the downside.

    [GBP, USD]
    The pound, being the principal financial market barometer of Brexit sentiment, has traded net moderately lower since the UK left the EU's common market and customs union. The hasn't been any significant border disruptions as a consequence of the UK leaving, although the hassle of custom declaration form filling has increased in trade with the EU. The UK's terms of trade with the EU has eroded in the Brexited world, despite the deal, with the key financial services sector left in a strategically more precarious position than before, with participation in EU markets dependant on the latter's equivalency rules -- although London's competitive advantage in this area should protect the sector over the near- to-medium term. There is also potential for pent up business investment, with Brexit uncertainty having finally cleared, while the UK is ahead of the pack in rolling out a Covid vaccination program. A pound weakening bias may prevail for a time, but with the government aiming to have nearly 25% of the UK population vaccinated by mid February, including all of the most at-risk groups, the pound looks a much better bet in the bigger view. UK nations went into a 'tier 5' lockdown last week, the most restrictive level since the full lockdown of spring last year, although there is already talk of a yet more restrictive 'tier 6' being introduced. Under the prevailing tier 5, manufacturing, auto repair businesses, DIY and garden stores, remain open, along with food sellers. High street retail, aviation and other public transport, along with the hospitality sector, are bearing the brunt of the lockdown, as in other nations, although the percentage impact on GDP from these sectors being closed is slightly bigger in the UK than most peers. The UK economy underperformed its G20 peers during lockdowns last year, so there is some thinking in market narratives that the UK will be apt to underperform again (although the way the UK compiles GDP data relative to other G20 nations may have exacerbated the picture). The UK data calendar this week is highlighted by the release of production, monthly GDP and trade data for November. Given the fast changing realities (new Covid lockdown, rapid vaccination program) the data is particularly backward looking, so will limited, if any, market impact.

    [USD, CHF]
    The recent weakening in the Swiss fran will have been 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 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 lifted to a six-day high at 1.2766, extending the rebound from the 33-month low that was seen last week at 1.2628. The increased yield attractiveness of the U.S. dollar, along with a dip in oil prices today, have maintained the pair's buoyancy.

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