Home > XE Currency Blog > XE Market Analysis: Europe - Oct 23, 2020

AD

XE Currency Blog

Topics7508 Posts7553
By XE Market Analysis October 23, 2020 3:52 am
    XE Market Analysis's picture
    XE Market Analysis Posts: 5432
    XE Market Analysis: Europe - Oct 23, 2020

    The dollar is trading moderately firmer against most other currencies, with the yen being the exception. Global stock markets are lacking direction, although the surface calmness belies an underlying skittish sentiment with hopes fading for a pre-election fiscal stimulus deal in the U.S. and with the looming elections inspiring a degree of reservation in investment decisions. Regarding the U.S. elections, polls point to a Biden presidency, but it is less clear if his Democratic party can take control of the Senate. If not, then Congress will remain split at least until the mid-term elections in two years, which will limit the scope for policy changes and crimp Democrat ambitions for expansive fiscal policy. Rising new Covid cases, especially in Europe, but also now in many U.S. states and Canada, also continues to be a concern, as the containment measures are having an impact on economic activity, albeit much more moderately compared to that seen during the global lockdowns earlier in the year. This backdrop is helping underpin the dollar, which, having found its footing following a mid week drop, remains a haven currency, alongside the yen. The DXY USD index has posted a three-day high at 93.12, while EUR-USD has concurrently dipped to a three-day low at 1.1787. Cable has made a two-day low at 1.3051, and the pound is fractionally weaker versus the euro. Intensive future relationship talks between the EU and UK are continuing. A narrow trade deal is expected, though perhaps the EU and UK might conceivably amaze everyone with a much more comprehensive deal than is being expected. The Covid situation may be a motivation for this, and it should be remembered that the two sides are starting from perfect equivalence, so a broad agreement is entirely possible. Even some Brexit ideologues in the UK might have mooted that maintaining close alignment with EU rules may -- for now -- be the more pragmatic way forward given the Covid stresses. Elsewhere, USD-JPY is modestly softer after yesterday's rally stalled at 104.93. At prevailing levels around 104.70, the pair remains down by 1% on the high seen on Wednesday. AUD-USD and AUD-JPY dropped back quite sharply after rising on the back of an above-forecast composite PMI reading out of Australia.

    [EUR, USD]
    EUR-USD dipped to a three-day low at 1.1787. The euro remains up by over 0.7% on the dollar over the last week. Real interest rate and real yield differentials are mildly bullish for EUR-USD, while this week's successful first joint EU offering of social bonds, which will finance a jobs program, has both attracted foreign capital and shored up the reputation of the euro. Data this week also showed a rise in the Eurozone's current account surplus. Markets are also discounting a limited free trade deal between the EU and UK, which has been another positive for the common currency, in addition to the pound. This backdrop should curtail downside potential of EUR-USD. However, downside possibilities could become more pronounced if risk aversion in global markets were to intensify to the extent that capital is shifted to the haven offered by the liquid U.S. Treasury market. Global asset markets remain skittish, as they have all week, with investors pondering the uncertainties presented by the surge in Covid cases in Europe and elsewhere, including now in many U.S. states and in Canada, and which are leading to ever more restrictive countermeasures. The ongoing delay in new U.S. fiscal stimulus and the event risk posed by the upcoming U.S. elections, particularly the perceived risk of the result being contested, are other uncertainties.

    [USD, JPY]
    USD-JPY is modestly softer after yesterday's rally stalled at 104.93. At prevailing levels around 104.70, the pair remains down by 1% on the high seen on Wednesday. The sharp decline was largely driven by dollar weakness, though the U.S. currency has since found a footing. The yen is also firmer against other currencies today. EUR-JPY is down for a third straight day, printing a four-day low at 123.42. AUD-JPY dropped back quite sharply after printing a four-day high (which was seen after an above-forecast composite PMI reading out of Australia). Japanese inflation data showed the headline September CPI rate fall to 0.0% y/y from 0.2% y/y in the month prior. Core CPI lifted slightly, to -0.3% y/y from -0.4% in August. When adjusting for the deflationary impact that the government's travel discount program has been having, core CPI is 0.0% y/y. This compares to the 1.7% y/y in U.S. CPI, which means that, with interest rates at near zero in both countries (Japan's policy rate at -0.1% and the mid range of the U.S. Fed funds target at 0.125%), real interest rates are higher in Japan than they are in the U.S. -- a mild, all else equal, negative for the nominal USD-JPY rate. In other data, Japan preliminary October PMI came in near expectations at 46.7 after the 46.6 reading in September. This is the ninth consecutive month the index has been below 50.0, indicating contraction in the private sector of the economy, and lagging relative to most peer economies, which is part reflective of the relatively old age demographic in Japan. Both Japan and China heading towards resuming travel between the two nations, which reflects the relatively contained status of the Covid coronavirus in Asia. The biggest directional force on the Japanese currency will likely 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, is recognized in the currency market and has established the yen as a low-beta haven currency.

    [GBP, USD]
    Cable has made a two-day low at 1.3051, and the pound is fractionally weaker versus the euro, though the UK currency remains comfortably up on week-ago and month-ago levels. The currency market is anticipating a limited trade deal between the EU and UK. Face-to-face talks between the two resumed yesterday for the first time since last week after a predictable and tetchy stand-off between Boris Johnson and the EU, or more particularly France and other so-called coastal 8 EU nations, which have been demanding unchanged fishing access to British waters. EU negotiator Barnier was earlier in the week reported by the BBC to have been "frustrated" with leaders of coastal EU nations for not (yet) allowing him to proceed on tackling inevitable compromises on fishing rights. Perhaps he arrived in London today with authorization to open up this front. For the coastal 8, it's a choice between no fishing rights in UK waters under a no deal scenario versus reduced quotas with an agreement. With a limited trade deal, and even taking into consideration the UK's progress in signing continuity agreements with non-EU trading partners, the UK economy and the pound would look vulnerable 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. Uncertainty about the UK's outlook will likely remain well into 2021, as the relationship between the UK and the EU will be an evolving one. This backdrop, along with the direction of travel in the Covid situation and associated restrictions, should be viewed as potential negatives for the pound, given the risk of lower foreign capital inflows, which are needed to offset structural outflows generated by the UK's large current account deficit. This said, it should also be acknowledged that the EU and UK might conceivably amaze everyone with a much more comprehensive deal than is being expected. The Covid situation may be a motivation for this, and it should be remembered that the two sides are starting from perfect equivalence, so a broad agreement is entirely possible. Even Brexit ideologues in the UK might be persuaded that maintaining close alignment with EU rules -- for now -- may be the more pragmatic way forward given the Covid stresses.

    [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 has settled to a narrow orbit of the 1.3150 level, tracking the lack of direction in oil prices currently. The U.S. dollar has also found a footing after dropping across-the-board earlier in the week. USD-CAD has been trending lower since March, though there are derailing risks, including the U.S. election and the trend toward ever more draconian Covid-related measures as the northern hemisphere heads into winter, which is crimping global growth.

    Paste link in email or IM