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By XE Market Analysis March 25, 2021 5:32 am
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    XE Market Analysis: Europe - Mar 25, 2021

    The dollar has posted fresh highs in a continued divergence from U.S. Treasury yields, which have remained broadly stable over the last day. Global stock and commodity markets remain in turbulent waters, which has been maintaining a safe haven bid for the greenback. The souring in relations between China and western nations this week remains a concern, the latest development being news that the U.S. securities regulator is taking measures that would de-list foreign companies from U.S. exchanges if they failed comply with U.S. auditing standards, alongside a requirement to disclose any government affiliations. It is widely understood that such a move would single out Chinese companies the most. Also on the worry list are the new lockdown measures being taken in much of Europe, disruptions in vaccination supplies, and a possible U.S. tax hike. There are also concerns about new SARS-Cov2 variants that are both more transmissible and resistant to current vaccines, and although there is a lack of hard evidence that this is becoming a major problem as yet, it is the principal justification behind the UK and other governments decisions to greatly limit international travel. Against this backdrop, the DXY dollar index printed a fresh four-month high, at 92.69, while EUR-USD clocked a new four-month low. USD-JPY lifted back above 109.00, while Cable forayed below 1.3700.

    [EUR, USD]
    We remain bearish on EUR-USD. The ECB this month surprised markets by announcing a ramp up in its asset purchase program in an effort to dampen rising yields. Markets are also focusing on growth and yield differentials, and the U.S. economy is widely seen outpacing the Eurozone and other peers this year, thanks in large part to the massive upcoming fiscal spending spree. Eurozone interest rates are near the most negative in the world (barring Swiss rates), and there is little expectation for the ECB to tighten policy, contrasting to the debate about the Fed, and the possibility it may be forced to tighten sooner than expected.

    [USD, JPY]
    The yen has lifted in recent days amid the narrowing in the U.S. over Japan yield differential (amid a correction in U.S. yields), alongside a backdrop of sputtering global stock markets. The BoJ last week widened the target band under its yield curve control policy and removed explicit targeting on ETF purchases, giving the central bank room to draw in stimulus. We continue to expect that the yen will retain an overall softening bias, with JGB yields to remained relatively rooted to U.S. Treasury and other sovereign yields. The Japanese currency is registering as the weakest of the main currencies on the year so far because of this.

    [GBP, USD]
    The pound has remained under pressure against a generally firm dollar while faring better against other currencies. The much stronger than expected PMI data out of the UK yesterday evidenced the relatively robustness of the economic recovery, at least compared to most other European economies. Data yesterday also showed a a surprising drop in CPI, to a rate of just 0.4% y/y in February after 0.7% y/y in the month prior. The data will likely prove to be an aberration, with a sharp burst of base-effect y/y increases set to kick in over the coming months, due to the sharp drop in commodity and other prices that was seen as a consequence of the global measures taken to combat the pandemic a year ago. As for the PMI, data, the preliminary March surveys for the manufacturing and services sectors came in much stronger than expected, with the headline composite reading rising to a seven-month high of 56.6, up from 49.6 in February. The median forecast had been for a much more modest improvement, to 50.6. A rebound in sales into easing lockdown measures, which has come on the back of a so-far successful and rapid Covid vaccination program, has driven the improvement. Consumer confidence increased and the survey highlighted a surge in demand for residential property services. The survey also showed that both input and output price measures spiked markedly. We remain bullish on the pound, on the proviso that the global pandemic recovery trade remains intact as the year progresses. There are concerns about the emergence of new variants that will render existing vaccinations obsolete, or at least less effective, which is the reason behind the UK government's draconian decision to make it illegal for its citizens to take foreign holidays in the months ahead.

    [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 settled after rallying strongly out of the 37-month low that was seen last week at 1.2363. The dollar's yield differential advantage narrowed somewhat from levels seen last week, while oil prices have been amid the biggest correction in over five months, which has been weighing on the Canadian dollar and other oil correlating currencies. We expect oil prices to remain soft, given the demand destruction being caused by the re-implementation of lockdown measures across much of Europe. We had been noting waning upside momentum in the the bullish oil price trend, with prices having become quite lofty, having long since been re-established to pre-pandemic level norms, while global demand has continued to lag behind pre-Covid levels. The OPEC+ group have maintained tight quotas through to April, though the discipline is looking increasingly likely to falter, with Russia in particular chomping at the bit to increase supply. U.S. shale production will also continue to ramp higher, despite some hindrances imposed by the Biden administration.

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