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By XE Market Analysis June 11, 2021 4:11 am
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    XE Market Analysis: Europe - Jun 11, 2021

    The dollar has traded softer so far today, tracking an extended decline in longer-dated U.S. Treasury yields, which has seen the 10-year T-note yield hit a fresh three-month lows under 1.440%, which is nearly 10 bp down on yesterday's peak. The magnitude of the greenback's declines has been limited, though enough to see two-day lows versus the euro and pound, and a four-day low in the case of the Australian dollar. The U.S. currency has, meanwhile, remained within yesterday's ranges against the yen and Canadian dollar, among other currencies. What's remarkable is this price action being seen in the wake of data yesterday showing that U.S. CPI hit a rate of 5.0% y/y in May -- the sharpest clip since 2008. In the Treasury market, the word is that bond bears have been in the final throws of capitulation, becoming accepting of the Fed's steadfast view that inflationary pressures will prove to be a transitory phenomenon and long-term inflation risks are low. Reflecting this, the 10-year Treasury break-even rate, which is a gauge of the level of inflation priced in over the next decade, have fallen to 2.32% from the eight-year high of 2.55% that was seen last month. The ECB's policy decision has also been in the mix as it stuck to its commitment of significantly higher PEPP purchases, which disappointed some, including ourselves, who had been anticipating the removal of the word "significantly" from the bank's statement. Going forward, the dollar is likely to remain with an overall softening bas. With the Fed holding out with ultra-accommodative monetary policy, the notably higher prevailing inflation rate in the U.S. relative to peers imparts a negative dynamic on the nominal value of the U.S. currency. We particularly remain bullish on the Canadian dollar and other cyclical currencies. Oil prices, underpinned by the combo of ongoing sub-capacity output from the OPEC+ group and rising global demand, look set to foray further into 32-month high territory. Industrial commodity prices can also expect to remain underpinned given the level of fiscal and monetary stimulus in the works globally.

    [EUR, USD]
    EUR-USD edged out a two-day high at 1.2196. The dollar has traded softer in concert with the sharp drop in U.S. Treasury yields, despite the hotter than expected U.S. May CPI reading, which hit a rate of 5.0% for the first time since 2008. Markets are evidently buying into the inflation-is-transitory view that is being touted by the Fed. The ECB, meanwhile, at its policy review yesterday stuck to its commitment of significantly higher PEPP purchases, which disappointed some, including ourselves, who had been anticipating the removal of the word "significantly" from the bank's statement. This has likely curtailed EUR-USD's upside potential, although the higher prevailing inflation rate in the U.S. relative to the Eurozone, is an-else-equal bullish dynamic for the pairing. At this point, we retain a bullish view on EUR-USD. We don't expect next week's FOMC will shift the needle much on prevailing policy expectations, with Fed now widely expected to remain in inflation-tolerant mode. Technically, it must be noted that EUR-USD has lost upside momentum after rallying late March through to the five-month high that was clocked in late May at 1.2267. The 1.2250-70 area can be considered a strong resistance region.

    [USD, JPY]
    USD-JPY has continued to oscillate around the 109.50 level. The sharp drop in U.S. Treasury yields yesterday weighed on the pair. The failure to sustain gains above 110.00 after foraying above here first time in two months last week, also appears to have weighed on sentiment somewhat. With the prospect of Fed tapering having been put back to "later" from "sooner" following damp May U.S. jobs report, the pronounced U.S. versus Japan inflation differential stands out as a negative dynamic for the nominal level of USD-JPY (aka USD-JPY bearish). But, there are offsetting forces at play, not least of which being the yen's proclivity to inversely correlate with global market stock market direction, which in the latest phase, with the MSCI all-country stock index having hit record highs this week, has been a negative for the Japanese currency. The yen is a low yielding currency of a surplus economy, and tends to weaken during risk-on phases in global markets, and strengthen during times of pronounced and sustained risk aversion. It should be of no surprise that the yen has been the weakest performing of the G10+ currencies during the reflation trade. The Japanese currency, for instance, is registering a loss of over 20% against the Australian dollar from levels seen a year ago, when many of the world's biggest economies were in the grips of 'mother' lockdowns.

    [GBP, USD]
    Cable nudged out a two-day high at 1.4186, which reflected boarder dollar softness, which has been a consequence of the tip lower in U.S. Treasury yields. The lift has returned the pair back towards recent range highs. The pound yesterday outperformed, rising, for instance, by nearly 0.5% from the nine-day low it saw against the euro while rallying out of the nine-day low it saw versus the yen. The UK currency remains the second strongest performing of the G10+ currencies on the year so far. The Canadian dollar is 1.7% up on sterling over this period. The weakest is the yen. The UK released April and second-revision Q2 GDP data, alongside April industrial production and trade data. Monthly GDP rose 2.3%, slightly beating expectations, though manufacturing, production and construction data spoilt the party. With virus restrictions gradually eased over the last months as vaccination progressed, the data naturally remains uneven, but survey data suggests that growth is broadening and strengthening now. The prognosis for the months ahead is looking good. While there has been a creep higher in new Covid cases in the UK, which has caused the prime minister to publicly ruminate that the fourth and final phase of the government's "roadmap" to reopening, scheduled for June 21, might be delayed, there are good grounds to expect this won't develop into a full blown wave. The spread, which is being driven by the Indian variant, is mostly among younger, unvaccinated people, while the the vaccinated majority are proving to be resistant. We retain an overall bullish view on the pound. The UK's main equity indices are replete with globally-focused cyclical stocks, which continue to trade at a discount relative to global peers, and which should benefit as major economies rebound at a time when investors are searching for value. Markets will be on heightened state of alert to incoming policy signalling from BoE MPC members afters Vlieghe said recently that an "early" rate hike was possible, provided there was a smooth transition out of the furlough. The furlough scheme ends on September 30, so Vlieghe's remarks suggest that big decisions on policy will be made after this.

    [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]
    We remain bullish on the Canadian dollar and other cyclical currencies. Oil prices, underpinned by the combo of ongoing sub-capacity output from the OPEC+ group and rising global demand, look set to foray further into 32-month high territory. Industrial commodity prices can also expect to remain underpinned given the level of fiscal and monetary stimulus in the works globally. USD-CAD has ebbed back from recent range highs, back to levels under 1.2100, leaving horizontal resistance at 1.2135 and 1.2150 unchallenged. The pair has been down trending since March 2020, and trend following remains the order of the day.

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