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By XE Market Analysis October 14, 2020 4:09 am
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    XE Market Analysis: Europe - Oct 14, 2020

    The pound is under pressure, and is showing about a 0.5% decline on the day so far against the dollar and yen, and about a 0.4% decline versus the euro. It's the eve of the EU summit. Boris Johnson said that the "shape" of a deal must be visible by tomorrow, which is a deadline set in fudging language. Johnson and the European Commission head von de Leyen will be talking this afternoon via video conference, presumably to establish whether a "shape" of a deal is in view. The rhetoric from both the UK and EU has reached fever pitch, with both sides strongly emphasising that there will not be a deal at any price. The apparent extreme hawkishness of Spain and France on fishing rights is notable, while Johnson is under pressure from the powerful ERG faction of his party not to concede on level playing filed rules. Sources cited by both Reuters and Bloomberg claim that EU leaders will be issuing a communique later declaring that there hasn't been sufficient progress for a deal. The stakes are enormous, especially for the UK, both economically and politically, and in consideration of this we continue to expect there will be a deal, albeit a limited one. Elsewhere, the dollar and yen are holding firm. EUR-USD has ebbed into one-week low territory in the lower 1.1700s. USD-JPY has become rooted around 105.50, while yen crosses are softer. EUR-JPY and GBP-JPY, for instance, are trading at nine- and 12-day lows, respectively. Chinese demand for JGBs is at a three-year high, reportedly. A JPMorgan research note ponders that part of the reason may be to weaken the yuan, and notes that JGB yields are in fact favourable compared to German and Swiss paper. New Covid cases continue to billow in Europe. The Netherlands is going into a near-full lockdown, and the UK Telegraph cited a senior government source saying that there is at least an 80% probability of a full "circuit breaker" national lockdown. We are bullish on the dollar and yen, and most bearish on sterling.

    [EUR, USD]
    EUR-USD has ebbed into one-week low territory in the lower 1.1700s. The euro has also been heavy against the yen and Swiss franc, while rising against the pound. Brexit risks should be a consideration, given the risk of a no-deal finality and also the risk of a narrow trade deal, which will erode both the UK's and EU's terms of trade. An ongoing salvo of dovish signalling from ECB policymakers is also in the mix, contributing in offsetting dollar weakness recently. Aside from the Fed itself, and partly in response to, many other central banks have been conducting similar messaging campaigns. The dollar, meanwhile, has been lifted by safe haven demand. While we remain dollar bearish in the big picture, the proclivity for capital to harbour in the safety of U.S. Treasuries means that this view hinges on the global growth outlook establishing a sustainable improving trend, and that in turn may hinge on the world getting through the Covid crisis. The world perhaps may want to get on the other side of the upcoming U.S. elections, too, given the concerns of the election being contested and the prevailing political balance failing to produce a much-needed fiscal package. Much needed given the incipient signs of the U.S. economy sinking into a liquidity trap (hoarding of cash is rendering monetary stimulus increasing impotent). Regarding the Covid situation in Europe and northern parts of North America, the next few weeks should be telling in terms of judging the actual public health impact -- as measured by ICU admissions and mortalities -- from the recent and ongoing billowing in positive Covid test results as compared to the impact seen back in March/April. If the actual public health impact remains low, which proponents of natural herd immunity argue it will (aside from arguing that community immunity is being underestimated, they point to the risk of false positive Covid test results fuelling what they call a 'case-demic', as seen in the winter season following the 2008-09 swine flu episode), then presumably there may be scope for reversing restrictions. If not, it'll be down to a vaccine to save the day.

    [USD, JPY]
    USD-JPY has become rooted around 105.50, while yen crosses are softer. EUR-JPY and GBP-JPY, for instance, are trading at nine- and 12-day lows, respectively. Chinese demand for JGBs is at a three-year high, reportedly. A JPMorgan research note ponders that part of the reason may be to weaken the yuan, and notes that JGB yields are in fact favourable compared to German and Swiss paper. Japanese data this week included a record 7.4% y/y rise in money supply as measured by M3, which is the broadest money aggregate. Not exactly a market mover, but given negative core inflation readings in Japan, is illustrative of the chronic liquidity funk the Japanese is in. At the same time, the negative inflation print has a tightening impact on real interest rates, which in turn imparts a positive bias on the yen. The biggest directional force on the Japanese currency will, however, remain 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 a long-established profile of a low-beta haven currency.

    [GBP, USD]
    The pound is under pressure, and is showing about a 0.5% decline on the day so far against the dollar and yen, and about a 0.4% decline versus the euro. It's the eve of the EU summit. Boris Johnson said that the "shape" of a deal must be visible by tomorrow, which is a deadline set in fudging language. Johnson and the European Commission head von de Leyen will be talking this afternoon via video conference, presumably to establish whether a "shape" of a deal is in view. The rhetoric from both the UK and EU has reached fever pitch, with both sides strongly emphasising that there will not be a deal at any price. The apparent extreme hawkishness of Spain and France on fishing rights is notable, while Johnson is under pressure from the powerful ERG faction of his party not to concede on level playing filed rules. Sources cited by both Reuters and Bloomberg claim that EU leaders will be issuing a communique later declaring that there hasn't been sufficient progress for a deal. The stakes are enormous, especially for the UK, both economically and politically, and in consideration of this we continue to expect there will be a deal, albeit a limited one. Reaching a deal would mean Johnson disappointing the ERG, and Spain, France and UK making some concessions on fishing. A no-deal scenario cannot by ruled out. Any news of a deal would likely boost sterling over the near term, but even with a deal, and even with the UK's progress in signing continuity agreements with non-EU trading partners, the UK will see its terms of trade position deteriorate.

    [USD, CHF]
    The Swiss franc has been continuing to trend with a firming bias, consistently rebounding from bouts of weakness in recent months. This has seen EUR-CHF repeatedly ebb back from brief forays above 1.0800, and the cross has fallen to the lower 1.0700s in the latest phase as markets anticipate revamped monetary easing measures from the ECB. The franc has a proclivity to ascend on the influence of incoming interest and other domestically owned investment receipts from assets held abroad, alongside net inflows generated by Switzerland's trade surplus. A higher franc has been imparting deflation, 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 the production of Swiss exports (perpetuating the nominal trend by limiting the decline in the real effective exchange rate). The SNB, nonetheless, explicitly targets the exchange rate as one of the means to achieve its policy goals. At its quarterly monetary policy review last month, the central bank stated that the franc remains "highly valued" and said it is ready to "intervene more strongly in the foreign exchange market".

    [USD, CAD]
    USD-CAD scaled to a five-day high at 1.3158, building on the rebound from Monday's one-month low at 1.3099. The pair has scope to run higher given the risk-wary backdrop in global markets, which both supports the U.S. dollar and weighs on oil prices. On Canada's domestic front, rising positive Covid tests are becoming a problem as they are leading to economically disruptive restrictions, similar to Europe and parts of the U.S.

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