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By XE Market Analysis January 21, 2021 4:40 am
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    XE Market Analysis: Europe - Jan 21, 2021

    The DXY dollar index edged out a six-day low at 90.25 in what is now a third consecutive day of lower lows, despite both EUR-USD and Cable, while buoyant, remaining below their respective Wednesday highs. USD-JPY, however, printed a two-week low at 103.33, and AUD-USD saw a five-day high. USD-CAD remained heavy, just above yesterday's 33-month low at 1.2604. Oil prices came off the boil after yesterday nearing 11-month highs, with data showing an unexpected build in U.S. weekly crude inventories curtailing the market's upside, despite a re-acceleration in the global reflation trade. The main U.S. equity indices on Wall Street clocked fresh record highs yesterday, as did the MSCI Asia-Pacific index today. Base metals also rose, though remained below recent trend highs for the most part. Nickel was an exception, with futures hitting a 16-month high earlier. Despite the anticipation of new U.S. President Biden's massive $1.9 tln stimulus package, and the associated asset price surge, U.S. Treasury yields were subbed, with the long-bonds coming off one-year highs and the 10-year note yield dropping below 1.08% for the first time since early January. This aided dollar softness. Market sentiment seems to remain bearish on the dollar in context of the reflation trade (which is hinged on a vaccine-assisted return to societal normalcy, alongside massive global stimulus and an expected spending spree of built-up consumer savings), on the view that U.S. assets and by association the greenback are overvalued against peers and emerging markets. But the market at the same time seems less bearish on the dollar since the Georgia runoff elections, where the Democrats won control of the Senate, given the implications for growth and Fed policy. Republicans have been voicing their opposition to the magnitude of Biden's spending plans, though the Democrats desires should still find passage. There are some concerns, although expressed like footnotes in analyst notes and to little apparent effect on the mood Wall Street, about the regulatory and tax implications that the Biden administration will bring. Elsewhere, the BoJ left main policy settings unchanged today, as had been widely expected. 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.

    [EUR, USD]
    EUR-USD lifted to the mid 1.2100s, putting in some distance from the one-month low that was seen on Monday at 1.2055. The euro wasn't impacted much by a Bloomberg story, citing sources, confirming that the ECB is actively targeting spreads and thus borrowing costs for governments across the Eurozone, which doesn't come as a surprise. The ECB's board meets on monetary policy today. After the PEPP and TLTRO programs were bolstered in December, the central bank is unlikely to further top up the existing policy. The transformation of the PEPP volumes into a ceiling rather than a target has given the ECB some flexibility, although governments hooked on low rates will likely increase the pressure on the central bank not only to use PEPP in full but also to push out the end date of the program as far into the future as possible. Markets will watch for comments on the euro and the future of the inflation target amid the ECB's ongoing strategic policy review. The dollar, meanwhile, has been trading softer in recent days amid a backdrop of buoyant global stock markets. The 'looking-past-Covid' reflation trade seems to have stirred, following recent dormancy, aided by the anticipation of a big spending Biden era. The latest update of the 'Big Mac index' of the Economist magazine, which is a PPP measure of relative currency valuations, found the euro to be 9% undervalued relative to the dollar.

    [USD, JPY]
    The yen's 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]
    The pound broke higher yesterday, with EUR-GBP breaking through recent lows. The cross earlier extended declines, posting a fresh eight-month low at 0.8831. Cable concurrently punched above last week's trend highs to a fresh 32-month peak at 1.3718. Market narratives are talking about the breach of key downside technical levels in EUR-GBP, along with perkier than anticipated December inflation data out of the UK, which has come hot on the heels of BoE Governor Bailey and Deputy Governor Broadbent downplaying the negative interest rate option. UK December inflation figures saw headline CPI come in slightly warmer than expected, at at 0.6% y/y rate, up from 0.3% in the month prior. The median forecast had been for a rise to 0.5% y/y. Other pound positives, which we have been noting, include reports of long-term investor interest in UK assets over the last, which have been left undervalued by the impact of both the long Brexit process and Covid lockdowns (the UK economy having underperformed G20 peers during lockdowns last year). An illustration of this is provided by the January update of the Economist magazine's Big Mac index, a measure of 56 currency valuations according to the theory of purchasing power parity, which showed the the pound to be 22% undervalued against the dollar. Associated with this view is the fact that the UK is among the leaders of the pack in the rollout out of Covid vaccinations, and is on track to have nearly 25% of the population vaccinated including nearly all of the at-risk groups as soon as mid February. At this point, the UK government will start reversing out of restrictions, although most likely this will be in a cautious stage-by-stage process over several months.

    [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 remained heavy, just above yesterday's 33-month low at 1.2604. Oil prices came off the boil after yesterday nearing 11-month highs, with data showing an unexpected build in U.S. weekly crude inventories curtailing the market's upside, despite a re-acceleration in the global reflation trade. Front-month WTI crude futures dipped back under $53.00 after yesterday posting a six-day high at $53.82. At prevailing levels, oil prices are up by over 10% on the month so far. Unexpected drawdowns in last week's U.S. crude inventories underpinned prices, especially as this followed Saudi Arabia's announcement in the week before of a 1 mln barrel per day production cut in both February and March. There remain reasons for caution with regard to oil's upside potential, given demand-sapping Covid restrictions across the northern hemisphere, and with tanker-tracking data showing compliance among OPEC+ producers to maintain output quotas falling to 75% in December.

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