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By XE Market Analysis May 28, 2020 3:55 am
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    XE Market Analysis: Europe - May 28, 2020

    The dollar and yen have remained weak, albeit in the context of narrow ranges so far today. Global markets remain, overall, in risk-on mood, though geopolitical tensions about the Hong Kong issue have seen the Hang Seng and main Chinese stock indices decline. The Nikkei 225 closed up 2.3% at its best level since February 27th, breaking above its 200-day moving average on route. The index is now up Up 34% from the lows in March. The cocktail of reopening economies and massive global stimulus is pumping buoyancy into global stock markets, which in many cases, including the S&P 500, have recouped to pre-pandemic levels. The narrow trade-weighted USD index has settled in the upper 98.0s, above the 24-day low seen yesterday at 98.72. EUR-USD edged out a two-month high at 1.1035. Aside from the softer dollar, the euro itself has been buoyed by increasing signs that a deal on the EU recovery fund is nearing fruition. EUR-JPY printed a seven-week high, at 118.96, while EUR-GBP is within a few pips of two-month high territory. Elsewhere, the Aussie dollar has consolidated today after dropping sharply from the 11-week high that was pegged at 0.6680 against the U.S. dollar. The weakening in China's yuan has been mooted in some narratives as having sparked profit taking in the Australian currency. There is also conjecture, which could apply equally to stock markets, that, having returned to pre-crisis valuations, there is less reason to be bullish. While economies are reopening, they are not fully reopening for the most part, and it's clear that a full recovery, back to pre-pandemic/lockdown levels, isn't likely anytime soon. The U.S.-China stand-off is a wildcard risk, too. AUD-USD rallied by over 21% from its March-19th low at 0.5507 through to yesterday's high.

    [EUR, USD]
    EUR-USD edged out a two-month high at 1.1035. Aside from the softer dollar, the euro itself has been buoyed by increasing signs that a deal on the EU recovery fund is nearing fruition. EUR-JPY printed a seven-week high, at 118.96, while EUR-GBP is within a few pips of two-month high territory. EUR-USD continues to trade in a broad consolidation range near the halfway mark of the volatile range that was seen during the height of the global market panic in March, which was marked by 1.0637 on the downside and 1.1494 on the upside. Despite the fresh highs today, we still expect the pair to lack sustained directional bias for now. There is little divergence in central bank policy currently, with both the ECB and the Fed pursuing aggressively accommodative policy, with both Europe and the U.S. facing significant economic headwinds from virus-containing lockdown measures. Both are amid the early stages or reopening from lockdowns.

    [USD, JPY]
    The yen has remained on a softening tack as global markets remain in overall bullish mood, though geopolitical tensions about the Hong Kong issue have seen the Hang Seng and main Chinese stock indices decline. The Nikkei 225 closed up 2.3% at its best level since February 27th, breaking above its 200-day moving average on route. The index is now up Up 34% from the lows in March. The cocktail of reopening economies and massive global stimulus is pumping buoyancy into global stock markets, which in many cases, such as in Japan, have recouped to pre-pandemic levels. This backdrop has continued to see an abatement in the Japanese currency's safe haven premium. There are risks ahead. Not least is the Hong Kong situation, with China expected to implement its controversial security law, which will effective quash democracy in Hong Kong, and the U.S. and other Western nations set to take measures. The U.S. will likely strip Hong Kong of its "special status", which would significantly weaken the city's status as a world financial centre. Another risk to the rosy outlook, is the risk of a second wave of coronavirus infections as social and economic reopenings proceed. A case in point is Alabama in the U.S., where there has been a sharp spike in new confirmed coronavirus.

    [GBP, USD]
    The pound's pandemic-era proclivity to correlate with stock markets has been on display so far this week The causation of sterling's high-beta characteristic, which was seen during the 2008/9 financial crisis and again during this crisis, is a combo of the UK's open economy, large current account deficit, and relatively outsized financial sector, which renders the currency sensitive to risk-off phases, while on the flip side making it apt to outperform during the risk-back-on phases. Cable has consequently been on an roller coater, plunging in March, at the height of the market panic, by the most over a two-week period on record, which left a 35-five year low at 1.1409. The gain over the last day has pushed the pound back toward the lower reaches of a broad consolidation range that's been enduring since April. Research out of Lloyds bank in London this week suggested that, with the acute dislocations since in March now fading and markets regaining their posture, the pound's correlative link with global stock markets is weakening. Its Cross-Asset Risk Index has fallen from a positive correlation of 0.85, at the high, to 0.61 now. We continue to anticipate limit potential for a sustained recovery in sterling, which is presently trading at a near 7% year-to-date discount when averaged against the dollar, euro and yen. UK markets are discounting negative repo rate by year-end, while there remains a risk that the UK leaved its post-Brexit transition membership of the EU's single market (which includes 40 free trade agreements around the world) at year-end, which would put a large part of UK trade on much less favourable WTO terms.

    [USD, CHF]
    The SNB has successfully been putting a cap on the franc, which has seen EUR-CHF in recent weeks skirt along just above the five-year low that was first seen on March 9th at 1.0505 without breaching it. Weekly sight deposit data out of Switzerland has pointed to the extent of SNB franc selling over the pandemic crisis period, which was most acute in March before basing out as global governments and central banks acted with interventions and stimulus packages. A rise in sight deposits (money held by commercial banks) can suggest the francs turning up after being sold by the central bank. The 1.0500 level in EUR-CHF, while not a fixed floor, has clearly been a line in the sand of the SNB. The Swiss central bank has a long history of intervening to either limit of slow the pace of appreciation in its currency, which normally comes during periods of risk aversion in global markets and/or euro underperformance. From 2011 through to 2015, the SNB capped the franc via a 1.2000 floor in EUR-CHF. When the cap was abandoned in January 2015, the franc rallied by 30%, having become unfeasible for the SNB to counter the ECB's expansive monetary policies. A similar circumstance is afoot today, with the ECB maintaining expansive polices following a period of safe haven demand for the franc. In January, the U.S. added Switzerland to its list of currency manipulators. The move seemed a bit harsh given the franc is a demonstrably chronically-overvalued currency in purchasing parity terms (as illustrated by the Economist's Big Mac index), though the Trump administration argued that Switzerland should pursue a more expansive fiscal policy as a remedy.

    [USD, CAD]
    USD-CAD has remained heavy after yesterday printing its lowest level since March 12th, at 1.3725. The Canadian dollar, likely other commodity currencies and risk assets, are now back to levels prevailing before the global market panic of mid March. This should give market participants pause for thought, as reopening economies are only doing so partially, and there is a risk for a second wave of coronavirus infections as social and economic re-liberalization unfolds (witness the sharp spike in cases in the state of Alabama in the U.S.). As for oil price, which is a key influencer of the Canadian dollar, front-month WTI crude futures have tipped lower by over 3% today, posting a six-day low at $31.55, extending the correction from the 11-week high that was seen on Tuesday at $34.81. The outlook for oil is still bullish. OPEC+ adherence to planned production cuts is reportedly high, though Russia is disiring to increase output in July. U.S. output continues to fall amid the forced closure of hundreds of shale wells, with current pricing making such operations unviable. On the demand side, China and India are said to be increasing imports, while fuel use in general has been on the rise as economies emerge from lock down. Bigger picture, as long as the nascent recovery isn't scuttled by a second wave of COVID-19 infections, oil price risk going forward would appear to be to the upside.

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