Home > XE Currency Blog > XE Market Analysis: Europe - Nov 06, 2020

AD

XE Currency Blog

Topics7618 Posts7663
By XE Market Analysis November 6, 2020 5:10 am
    XE Market Analysis's picture
    XE Market Analysis Posts: 5542
    XE Market Analysis: Europe - Nov 06, 2020

    The dollar has found a footing after tipping sharply lower over the last three days, which mirrors a petering out in the risk-on positioning theme in global markets today. We're still awaiting on the U.S. election result. Markets are pricing in a Biden presidency and a split Congress, with Republicans likely to retain the Senate and with the Democrats retaining the House. Regarding Trump's litigation efforts, the general view seems to be that senior Republican leaders will break with Trump -- and many are already distancing themselves from him -- if and when the courts reject his claims of widespread voter fraud, assuming that Biden does indeed reach the 270 electoral college count threshold to win the presidency. The pricing out of a 'blue wave' Democrat sweep sparked the sharp drop in U.S. Treasury yields on the prospect for more restrained fiscal stimulus, and thereby prospects for less Treasury issuance. The 10-year T-note yield, even after rising out of lows, remains about a net 16bp lower from levels prevailing on Tuesday ahead of the election results, and yield differentials with gilts, bunds and JGBs, among other sovereign benchmark yields, remain narrower by 12bp-plus. The narrowing in yield differentials vectored the dollar's decline this week. As for Wall Street, the lack of Democrat control of the House spells a prospect for less tax and less regulation than there would have been otherwise. The S&P 500 closed yesterday with a 7.4% gain on the week so far. The biggest gains out of the main currencies have been the dollar bloc and other commodity-correlating currencies. Most commodity prices are up strongly versus week-ago levels. Oil prices are up over 7%. The pound has been mixed this week, gaining on the dollar, holding near net unchanged levels versus the euro, while losing ground to the Australian dollar and other commodity correlators. EU trade negotiator Barnier raised eyebrows earlier in the week by stating that "very serious divergences remain" with the UK, a message that has since been repeated by other officials. Judging by the performance of the pound, markets are evidently not perturbed, expecting a last minute climbdown. The final deadline for a trade deal is understood to be the end of next week. The U.S. October payrolls report is up today, where markets are expecting the headline to show the lowest job gain in five months as a consequence of flagging momentum due to fiscal stimulus ending and new Covid restrictions being implemented in various parts of the country.

    [EUR, USD]
    EUR-USD has remained buoyant after posting an 11-day high yesterday at 1.1861. The pair rallied sharply, form a 1.1603 low, this week on the back of a weaker dollar. The pricing out of a Democrat sweep saw U.S. Treasury yields dive, due to the prospect of less issuance than would have been otherwise, while sparking a strong rally on Wall Street on the prospect for less tax and less regulation, which in turn ignited a risk-on positioning theme in global markets. This saw safe haven positions in the dollar unwind rapidly, while the decline in yield differentials versus other sovereign benchmark yields vectored dollar declines. Markets are pricing in a Biden presidency and a split Congress, with Republicans likely to retain the Senate and with the Democrats retaining the House. The U.S. October payrolls report is up today, where markets are expecting the headline to show the lowest job gain in five months as a consequence of flagging momentum due to fiscal stimulus ending and new Covid restrictions being implemented in various parts of the country. Bigger picture, the outlook for the dollar is bearish, with a risk that there is a relative weakening in capital inflows to the U.S., which are needed to fund the current account deficit. The demand for stimulus funding is strong in many world economies given the impact of the Covid pandemic. China may also be strategically downsizing the relative size of its Treasury holdings. Add to this, the negative real interest rates and yields in the U.S. and the Fed's lower-for-longer monetary policy rubric. As for EUR-USD, countervailing forces (to a weak dollar scenario) are at play, including the lockdown status and otherwise tight restrictions across Eurozone economies, along with the ECB's intensified dovish lean, which includes an explicit mention of the desirability to head of euro appreciation given the tightening effect of a rising exchange rate on real interest rates. EUR-USD may not, thereby, by the best vehicle to express a dollar bearish view.

    [USD, JPY]
    USD-JPY has broken lower this week on a yield differential dynamic, with the 10-year T-note yield differential over the 10-year JGB yield dropping by about 14-15 bp from levels seen ahead of U.S. election results on Tuesday, even allowing for the 3bp-plus lift out of lows. Taking into account the 1%-plus inflation rate in the U.S. and the currently negative inflation rate in Japan, and the impact on the real yield differential is slightly magnified. USD-JPY has been trending steadily lower since June from levels above 109.00 with a fairly steady momentum. The 10-year real constant maturity Treasury yield has concomitantly declined over this period, and at the most recent indicated level of -0.86% (from yesterday) is exactly 50 bp down on the peak seen on June 4th, and is down by 94 bp from the 2020 opening level on January 2. The real 10-year JGB yield has been comparatively steady, and the diverging differential has been imparting a downward force on the nominal exchange rate between the dollar and yen. USD-JPY's break below 104.00 triggered stop loss and option-related selling, according to market narratives, which helps explain the yen's decoupling from its usual inverse correlation with global stock market performance today, although the Japanese currency is still registering modest declines versus the euro and dollar bloc currencies. The pair extended lower today, posting a fresh eight-month low at 103.36 and marking a near 5% decline on the year so far.

    [GBP, USD]
    The pound has been mixed this week, gaining on the dollar, holding near net unchanged levels versus the euro, while losing ground to the Australian dollar and other commodity correlators. EU trade negotiator Barnier raised eyebrows earlier in the week by stating that "very serious divergences remain" with the UK, a message that has since been repeated by other officials. Judging by the performance of the pound, markets are evidently not perturbed, expecting a last minute climbdown. The final deadline for a trade deal is understood to be the end of next week.

    [USD, CHF]
    EUR-CHF has dropped back under the 1.0700 after a brief foray above. Risk-off positioning and recent weakness in the euro, which has been concomitant with the ECB levelling-up monetary accommodation, has been weighing on the cross. The ECB's policy course has been in effect supplementing the Swiss currency's chronic firming bias by weakening the euro, with the EUR-CHF cross being a proxy of the franc's trade-weighted exchange rate. The franc has a fundamental underpinning rooted in Switzerland's strong balance of payments position, which features a large current account surplus to GDP. Switzerland also has the status of having the second highest GDP per capita in the world. While the SNB implements a punishing -0.75% deposit rate, real interest rates are still lower in the U.S. than they are in Switzerland, which is mathematically bearish for the nominal USD-CHF exchange rate, all else equal -- and albeit very modest. 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 stated at its last quarterly monetary policy review that the franc remains "highly valued" and said it is ready to "intervene more strongly in the foreign exchange market."

    [USD, CAD]
    USD-CAD has settled above lows seen yesterday, which follows a near 2% decline this week. The pair saw some relatively extreme price action during the week, but the net outcome has been weaker U.S. dollar and firmer commodity-correlating currencies, including the Canadian dollar. The pricing out of a Democrat sweep in the U.S. elections caused U.S. Treasury yields to dive, and generated a rally on Wall Street and global stock markets given implications for less tax and less regulation than there would otherwise have been, which is typically a potent recipe for a bullish stock market. WTI benchmark oil prices are showing a gain of over 13% from the low seen on Monday, ahead of the U.S. election, though remain down by nearly 8% from the highs that were seen a couple of weeks ago, before the likes of German and France announced they were heading back into lockdowns. There has been a realization among investors that the lockdowns in Europe are in the main much less restrictive than they were the first time around, which has seen some position adjusting to reflect a less pessimistic view than hitherto seen. October employment reports are out from both the U.S. and Canada today. Both are expected to show a picture of flagging momentum in job growth. New Covid restrictions and the end of fiscal stimulus in the U.S. are to blame. Investors have reason to look across the valley to brighter pastures, with new U.S. stimulus to be expected once the election results are sorted, and with the many leading candidate Covid-19 vaccines showing good results in advanced-stage testing. We anticipate USD-CAD's bear trend, which has been unfolding since March, to remain intact.

    Paste link in email or IM