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By XE Market Analysis October 21, 2020 4:49 am
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    XE Market Analysis: Europe - Oct 21, 2020

    The dollar is softer across the board amid a backdrop of buoyant global stock markets and declining risk premia. U.S. House speaker Pelosi said that she is hopeful that a deal on fiscal stimulus can be reached this week, while markets are also factoring in rising prospects for further central bank stimulus, especially in Europe where the trend toward increasingly draconian Covid measures is threatening a double dip recession. The prevailing upbeat mood could change in a flash. The Senate is unlikely to pass the sizeable package that the Democrats and White House appear to be narrowing in on. The upcoming U.S. election poses event risk given the perceived risk of the outcome being contested, although the magnitude of Biden's lead in the polls has attenuated this perception somewhat. The there is the Covid situation in Europe, and in Canada and many U.S. states, where new cases are billowing. While this is inspiring increased expectations for further stimulus, this should be weighed against the reality of falling economic activity of an unknown duration. Ireland, for instance, announced a 'level 5' full national lockdown, which will last six weeks. Wales is also entering a full lockdown, while even Sweden is implementing localised lockdown measures (on a voluntary basis). Among currencies, the DXY USD index fell to a one-month low at 92.78 in what is a fourth consecutive day of decline. EUR-USD concurrently lifted to a one-month high at 1.1864. The euro outperformed yesterday on the back of strong investor demand for the EU's first offering of social bonds, which will finance a jobs program. Data also showed a rise in the Eurozone's current account surplus. Today, however, the euro traded steadily against most currencies outside the case against the dollar. Elsewhere, USD-JPY fell to a six-day low at 105.16. Most yen crosses were stable. The pound rose 0.5% in posting a two-day high against the dollar at 1.3011, and showed modest gains against the euro and other currencies. The price action is revealing of the market's confidence that the EU and UK will reach trade deal.

    [EUR, USD]
    EUR-USD lifted to a one-month high at 1.1864. The euro outperformed yesterday on the back of strong investor demand for the EU's first offering of social bonds, which will finance a jobs program. Data also showed a rise in the Eurozone's current account surplus. Today, however, the euro traded steadily against most currencies outside the case against the dollar. Regarding the EU bonds, this was the first issue of the EU's €750 triple-A pandemic recovery fund, raising €233 bln. The evident popularity of the offering will likely raise demand for further joint issuance, especially from cash-strapped governments in Rome and Madrid. The jointly issued recovery fund is seen as a milestone by many analysts, and reducing Eurozone breakup risks. The increased confidence in the integrity of the eurozone, along with the the existence of a new AAA fund, should attract foreign capital. Together with the Eurozone's current account surplus (net inflow of remittances, the trade surplus, and net inflow of international interest receipts), this is a positive for the euro. The Eurozone also has a positive differential real interest rate differential versus the U.S., where inflation is running above 1% compared to mild deflation in the Eurozone. The inflation-adjusted yield on U.S. bonds is also at a negative differential to real Bund yields, at least out to the 10-year maturity. Overall, a bullish structure for EUR-USD. But, there are countervailing forces and risks. One is Brexit, and the risk of a no deal, although the stability of the pound reveals that market participants are confidence that a deal will be reached. Another is the surging Covid cases across Europe, which is leading to more stringent containing measures relative to the U.S., which could create a growth differential in favour of the U.S. The upcoming U.S. elections present risks too, given the perceived chance of the election being contested. Markets are anticipating another U.S. fiscal package, although legislation is unlikely to be passed this side of the elections, and the size and scope of future stimulus will be dependent on the election result. Overall, we are bullish on EUR-USD, especially in the longer term, though any fresh bout of risk aversion would likely support the dollar.

    [USD, JPY]
    USD-JPY fell to a six-day low at 105.16 on the back of broader declines in the dollar. Most yen crosses were stable, including AUD-JPY after steep declines over the last day. While risk appetite has picked up on expectations for further fiscal and monetary stimulus, globally, markets are likely to remain skittish, overall, into the U.S. elections, now less than two weeks away, given the perceived risk of it be contested, which in this scenario could lead to a messy political scene for a time and delay fiscal stimulus further (which looks unlikely to happen this side of the election). The ongoing surge in new Covid cases in the more northern parts of North America and, more especially, in Europe is alarming given the concomitant implementation of ever more draconian measures .The biggest directional force on the Japanese currency will remain shifting risk premia 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]
    The pound rose 0.5% in posting a two-day high against the dollar at 1.3011, and showed modest gains against the euro and other currencies. The price action is revealing of the market's confidence that the EU and UK will reach trade deal. The Brexit endgame remains in sharp focus. Talks are continuing between the EU and UK, though there has been no sign of a breakthrough, while Boris Johnson and senior minister Michael Gove have launched a high-profile campaign to encourage UK businesses to prepare for major changes, including a no deal scenario. A BBC journalist reported earlier in the week that the EU's chief negotiator, Bernier, has been feeling "frustrated" with leaders of coastal EU nations for not (yet) allowing him to proceed on tackling inevitable compromises on fishing rights. From the perspective of the so-called coastal 8, it's a choice between no fishing rights in UK waters under a no deal scenario versus reduced quotas with an agreement. While fishing is a low GDP contributor on both sides of the Channel, it's a highly politically sensitive area for all, and is totemic for Brexiteers. Currently more than half of the UK's annual fishing quota is foreign owned. The game of chicken between the coastal 8 and the UK continues, but surely a sensible resolution will be found. Regarding Johnson's controversial Internal Market Bill, the expectation is that he will concede by removing the offending passages in it -- i.e. the parts that would enable the UK government to unilaterally overwrite parts of the Withdrawal Agreement (likely his plan all along; a ruse aimed at strengthening a weak negotiating position). We remain bearish on the pound over the medium term. Swapping unfettered access to the EU's single market and customs union in place of a narrow free trade deal will see trading friction and costs rise. Note that Wales has announced it will be going into a 17-day full lockdown, and that Moody's has downgraded UK sovereign debt to Aa3 from Aa2.

    [USD, CHF]
    The Swiss franc has been continuing to trade 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. This along with Brexit risk, which has been weighing on the euro. 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 is down for a fourth consecutive day, posting a six-week low at 1.3080. Broad weakness in the U.S. dollar has been the principal driven today, and while oil prices are down by over 1% today, this follows crude hitting a seven-week peak yesterday. Buoyant global stock markets is also a positive backdrop for the Canadian dollar. The trend is firmly to the downside, though there are derailing risks, including the U.S. election and the trend toward more draconian Covid-related measures as the northern hemisphere heads into winter. For now, ongoing expectations for expansive global fiscal and monetary policies are keeping asset markets, and asset currencies, like the Canadian dollar, underpinned.

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