Home > XE Currency Blog > XE Market Analysis: Europe - Oct 08, 2020

AD

XE Currency Blog

Topics7501 Posts7546
By XE Market Analysis October 8, 2020 4:32 am
    XE Market Analysis's picture
    XE Market Analysis Posts: 5425
    XE Market Analysis: Europe - Oct 08, 2020

    The dollar has traded softer, inversely correlating with rallying stock markets on Wall Street. S&P 500 E-minis are up 0.7%, while the cash version of the index closed yesterday with a 1.7% gain. Progress in the piecemeal approach to pandemic support packages in the U.S. along with positive news from the Covid vaccine and treatment front have lifted investor spirits. The USD index (DXY) posted a two-day low at 93.50. EUR-USD lifted, but has remained just shy of yesterday's high at 1.1783, while Cable printed a two-day peak at 1.2956. The pound also posted modest gains versus the yen, and more modestly so against the euro. There has been brinkmanship between the EU and UK, with the EU's chief negotiator Barnier telling ambassadors he doesn't expect the UK to walk, eliciting a response from Boris Johnson that Britain will walk on October 15th if a satisfactory deal isn't struck. A Bloomberg article, citing EU sources, suggests that a deal is likely. The consensus expectation is for a limited tariff free, quota free deal, which we concur with. Elsewhere, the Australian dollar outperformed moderately, rising nearly 0.5% against the U.S. dollar in pegging a two-day peak at 0.7163. USD-CAD posted a 17-day low at 1.3235, weighed on by a combo of U.S. dollar weakness and a 1% rise in oil prices. USD-JPY plied a narrow range just below yesterday's three-week high at 106.12. As for the U.S. dollar, we are bearish in the bigger picture, which hinges there being a sustained recovery in risk appetite. Anticipated net outflows of both speculative and non-speculative capital from the U.S. would be the principal driver, with investors and reverse managers seeking higher returns globally in this scenario. The Fed's policy regime shift (which allows inflation to overshoot) is also a factor, and while the policy direction at other central banks may offset, the event of dollar weakness could exert a potentially strong downside influence on real interest rates and yields in the U.S., injecting a self-sustaining element in a dollar downtrend. One consideration is that the broad real effective dollar exchange rate, while down by over 4% from its 18-year high that was seen in March, remains at historically rich levels.

    [EUR, USD]
    EUR-USD lifted, but has remained just shy of yesterday's high at 1.1783. The dollar has traded softer, inversely correlating with rallying stock markets on Wall Street. Progress in the piecemeal approach to pandemic support packages in the U.S. along with positive news from the Covid vaccine and treatment front have lifted investor spirits. The USD index (DXY) posted a two-day low at 93.50. Uncertainties prevail: about U.S. fiscal policy, about next month's U.S. election, and the risk that it will be contested, about the Brexit endgame, and, increasingly, about new Covid restrictions and lockdowns in North America and, more especially, Europe. The scene is set for volatile markets in the coming weeks. We are bearish on the dollar, bigger picture, but the timing doesn't look right to act on this now, and might not be for some time. The weaker dollar thesis is structured on Fed policy alongside a net outflow of speculative and non-speculative capital, and requires a backdrop of positive risk appetite in global markets to function, to draw out capital parked in the safe haven of U.S. Treasuries and seek growth in global economies. It follows that the world needs to make it through the Covid crisis, either via vaccines, or by countries learning to live with the new pathogen in a manner that causes minimal curtailment of economic activity. Sweden provides a positive example in how this might be done, and Belgium recently bucked the trend in Europe by easing restrictions. But most governments in the northern hemisphere are nervous heading into the winter respiratory illness season. The Brexit endgame, even assuming it finishes with a deal, is likely to put a dent in the terms of trade positions in both the EU and UK, and more especially in the case of the latter. This, and the Covid situation in Europe, should maintain the ECB's accommodative bias. The central bank has been highlighting its concerns about recent strength in the euro's effective exchange rate, given its tightening effect on real interest rates in the Eurozone. For now, this backdrop should limit EUR-USD's upside potential.

    [USD, JPY]
    USD-JPY plied a narrow range just below yesterday's three-week high at 106.12. The yen is likely to remain apt to directional change on the back of shifting risk premia in global markets. Backed by a surplus economy, and one where yield-seeking domestic investors are apt to invest in foreign assets during times of confidence, but repatriate funds when times are uncertain, the yen has an established profile of a low-beta haven currency.

    [GBP, USD]
    Cable printed a two-day peak at 1.2956. The pound also posted modest gains versus the yen, and more modestly so against the euro. There has been brinkmanship between the EU and UK, with the EU's chief negotiator Barnier telling ambassadors he doesn't expect the UK to walk, eliciting a response from Boris Johnson that Britain will walk on October 15th if a satisfactory deal isn't struck. A Bloomberg article, citing EU sources, suggests that a deal is likely. The consensus expectation is for a limited tariff free, quota free deal, which we concur with. We are bearish on the pound. Even with a tariff free, quota free deal, the UK's loss of unfettered access to the single market and customs union would erode trade. UK exporters would face cost-increasing non-tariff barriers, such as customs formalities and regulatory barriers. The same would be the case for EU exporters to the UK, though the impact will be much magnified on the UK side of the Channel. Productivity would also be impacted, given reduced competition and reduced scope for businesses to benefit from economies of scale. This would be accompanied by less investment. The government would of course work to offset these impacts with new global deals, and it has signed many continuity agreements to cover for the loss of access to the EU's free trade agreements, but the fact is the UK is set to be jolted into worse trading terms with or without a deal. Financial services -- a golden goose that accounts for 22% government tax receipts -- is a particular concern. A Bloomberg article yesterday highlighted the steady stream of financial services resources that are being moved out of the UK to the Eurozone, and the fact that even with a EU trade deal in place, London will likely continue to lose business to Eurozone financial centres as the "equivalence" regime on rules would leave firms with long-term uncertainty (Brussels would be able to unilaterally decide if the UK's rules are to its satisfaction, while European nations are bent on drawing business away from London over the long term).

    [USD, CHF]
    EUR-CHF has ebbed back under 1.0800 again, reflecting the chronic proclivity for the Swiss currency to rise in nominal terms, from incoming interest and other investment receipts from assets held abroad, alongside the trade surplus. A higher franc drives down inflation, which to a degree offsets any loss in export competitiveness that a nominally firmer currency might otherwise entail, as there is a high import component in Swiss exports. The SNB, however, remains committed to limiting gains in the franc. At its quarterly monetary policy review last month, it stated that the franc remains "highly valued" and said it is ready to "intervene more strongly in the foreign exchange market". The cross has repeatedly failed to sustain gains above 1.0800 over the last couple of months, even though influence of the SNB's intervening hand may have been at play during the recent upside bursts. Total Swiss sight deposits of francs have risen sharply since the pandemic and consequential lockdowns took a grip on global markets back in March. Sight deposits can be viewed as a proxy marker of SNB intervention to sell francs in forex markets (after buying foreign currencies), which results in the crediting of newly created francs at commercial banks sight accounts. The rise in sight deposits also reflects SNB operations to boost liquidity via the COVID-19 refinancing facility. EUR-CHF remains below the seven-month peak that was seen in early June at 1.0921.

    [USD, CAD]
    USD-CAD posted a 17-day low at 1.3235, weighed on by a combo of U.S. dollar weakness and a 1% rise in oil prices. On Canada's domestic front, rising positive Covid tests are becoming a problem as they are leading to economically disruptive restrictions. Canada's September employment report is up on Friday, where we anticipate a 100.0k headline gain after the 245.8k rise in August, with unemployment seen ebbing to 10.0% from 10.2%.

    Paste link in email or IM