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By XE Market Analysis November 23, 2020 4:00 am
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    XE Market Analysis: Europe - Nov 23, 2020

    The dollar and yen traded moderately softer against most other currencies amid a buoyant sentiment in Asian markets, which propelled the MSCI Asia-Pacific ex-Japan stock index hit a new record high. Sterling outperformance was another theme. There have been various positive news, ranging from Covid vaccines and treatments, to encouraging corporate earnings and economic data, and from the Brexit front, which have collectively helped investors look beyond the prevailing surge in Covid positive tests results across the northern hemisphere. The U.S. government said vaccinations could start mid December for those most at risk and health workers, while UK authorities may approve the Pfizer vaccine this week and start distribution as soon as December 1. The U.S. FDA also approved Regeneron for use as a treatment (President Trump was treated with this). Above-forecast economic data came in from South Korea (exports), Singapore (GDP) and New Zealand (retail sales). As for Brexit, there are widespread reports of a deal being struck by mid this week, the BBC's European correspondent Katya Adler, for instance, reporting that "the general expectation is that a deal will be done in the next few days," while a source cited by Sky reported that a deal is "95% agreed." It has also become clear that officials are determined not to let the fishing rights issue, which is the principal obstacle (much more so than level playing field rules and governance issues), prevent a deal from being reached. A fudge is reportedly in the works, which would allow the fishing issue to be reviewed in the future. Sterling rallied. Cable posted a two-and-a-half-month high at 1.3333, while EUR-GBP has declined to an 11-day low at 0.8904. Elsewhere, the DXY dollar index posted a 92.22 low, which is 1 pip shy of the two-week lows seen last week. EUR-USD lifted to a 1.1880 high, remaining within Friday's range. USD-JPY traded a narrow range in the upper 103.0s. NZD-USD posted a 23-month high, and AUD-USD saw a five-day high. USD-CAD drifted lower, but remained with its Friday range. WTI oil prices hit a 12-week high.

    [EUR, USD]
    EUR-USD lifted to a 1.1880 high, remaining within Friday's range. The pair has consistently failed to sustain gains above the 1.1900 level for almost four months now. There hasn't yet appeared to be sufficient disequilibrium to drive the pair higher. Interest rates are near zero in both the U.S. and eurozone, and both the Fed and ECB are pursuing aggressive monetary easing policies, though a higher inflation rate in the U.S. means that the real interest rate in the U.S. is lower than in the eurozone. The U.S. is beating the eurozone on growth, while the eurozone is running a trade surplus relatively the the trade deficit in the U.S. The U.S. depends on capital inflow to fund its current account deficit, while the eurozone runs a strong balance of payments position. Overall, a picture of countervailing forces among these key metrics of exchange rate determination. We still retain a bearish long-term view on the dollar, however, which hinges on risk appetite holding up in global markets. The dollar's real effective exchange rate (as calculated by the BIS) remains at historically rich levels, and we expect broad declines in the U.S. currency over the longer term as investors seek higher yield value and growth opportunities around the world. An ongoing rotation out of too expensive tech stocks would fit this theme. The Fed's inflation-tolerant lower-for-longer policy rubric, and negative real interest rates in the U.S., are also considerations.

    [USD, JPY]
    USD-JPY traded a narrow range in the upper 103.0s. Yen crosses were steady-to-firmer, with AUD-JPY and NZD-JPY, for instance, posting respective five- and six-day highs. Japanese markets were closed today, while the MSCI Asia-Pacific ex-Japan equity index rallied to a fresh record high, aided by above-forecast data out of South Korea and Singapore, along with positive news from the Covid-19 vaccine front. Like many other winter-bound northern hemisphere nations, Covid cases are surging, which is causing tighter restrictions to be imposed on the economy, though this hasn't been having evident impact on the yen. The real interest rate differential between the U.S. and Japan is a mathematical negative for the nominal dollar vs yen exchange rate. This, along with the dollar's prevailing bias to underperform in phases of risk-on positioning, should keep USD-JPY on a steady-to-lower path. The yen's broader performance will hinge on 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]
    Brexit news has lifted the pound. The rally in the UK currency accelerated in London trading. Both Cable and GBP-JPY are showing gains of just over 0.7% at prevailing levels (9 AM in London). Cable has posted a 12-week high at 1.3380. EUR-GBP, meanwhile, has declined to an 11-day low at 0.8874, drawing in on the 12-week low see earlier in November, at 0.8858. Brexit news has been positive. There are widespread reports of a trade deal being struck by mid this week, the BBC's European correspondent Katya Adler, for instance, reporting that "the general expectation is that a deal will be done in the next few days," while a source cited by Sky reported that a deal is "95% agreed." It has also become clear that officials are determined not to let the fishing rights issue, which is the principal obstacle (much more so than level playing field rules and governance issues), prevent a deal from being reached. A fudge is reportedly in the works, which would allow the fishing issue to be reviewed in the future. We have been anticipating that win-win will prevail rather than lose-lose, and that an accord will be reached. The pound is likely to see further upside, especially on any concrete news that a deal has been reached, and with the UK reportedly close to giving the Pfizer vaccine (of which the UK pre-ordered 40 mln shots) regulatory approval as soon as this week, with a rollout starting as soon as December 1. The UK saw a bigger peak-to-trough GDP contraction than any other G20 nation in 2020 as a consequence of the national and global countermeasures taken to table Covid-19 (the essential reason being the UK's dependence on foreign capital inflows to fund its gaping current account deficit, and the shortfall in capital inflows as a consequence of the pandemic). The logic is that the UK should be a big economic benefactor in the vaccine-assisted return-to-normalcy scenario. The caveat here is how broad, or perhaps how narrow, a deal the EU and UK strike. A narrow a deal would mostly benefit manufacturing while leaving the dominant service sector vulnerable. Nearer term, the UK's preliminary UK PMI reports for November are up later. Given the Covid-related lockdown restrictions, which have been heavily focused on the hospitality and retail sectors, the consensus expectation is for a services-driven decline in the composite PMI reading, to 42.5 from 52.1. There is a silver lining of sorts, with the decline is much less sever than seen earlier in the year, when the composite PMI headline hit a 12.9 reading at is nadir in April.

    [USD, CHF]
    EUR-CHF has established a consolidation range around the 1.0800 level after recently rallying from sub-1.0700 levels. Recent risk-on positioning weighed on the Swiss franc with investors factoring in a sea change in optimism about a vaccine solution to Covid-19. 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 reversed of Friday's gain in making a low at 1.3047. The 12-day low seen last week is at 1.3032. The Canadian dollar's close correlation with oil prices continues. Front-month WTI crude futures rallied over 2% in pegging a 12-week high at $43.33. We remain bearish of USD-CAD. The OPEC+ group is considering extending the prevailing level of output quotas for three months (out to next March), and a six-month extension is also a possibility, aiming to support oil prices over a sustained period of relatively low demand as a consequence of Covid-19 related restrictions around the world. The decision is expected on December 1. The group estimates that a six-month extension would swing the oil market back into deficit (i.e. a supply deficit) in 2021. Add in the increased optimism for a vaccine-assisted route out of the prevailing Covid situation, this sets oil up for a sustained rally in oil. USD-CAD has been trending lower since March, and we anticipate there is more to come. The current trend low is at 1.2928, which was seen earlier in November, and which was the lowest level the pair has seen since October 2018.

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