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By XE Market Analysis October 26, 2020 5:55 am
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    XE Market Analysis: Europe - Oct 26, 2020

    The dollar is firmer against a backdrop of tumbling global stock markets as an ongoing surge in new positive tests for Covid in Europe and the U.S., and the course toward tighter restrictions, dulls the economic outlook. The U.S. and France set new records for positive tests for the coronavirus, while Spain announced a state of emergency. It should be noted (though often isn't) that there is likely a false positive issue (many academic papers have discussed this), which may be exaggerating the true picture of Covid prevalence. Hospital respiratory-condition ICU occupancy and the mortality rate from respiratory conditions are at near normal levels for this stage of the season across Europe. But, the fear is that this won't remain the case and we'll see a similar impact as we did back in March and April, and the dominant theory to tackle the coronavirus is to implement restrictions and lockdown if necessary. This backdrop has seen risk-off positioning take a hold again, which has been the on-and-off case over the last two weeks. More of the same seems likely in the weeks ahead. The DXY dollar index gained 0.3% in posting a high at 93.02, which reverses most of the decline see on Friday. EUR-USD concurrently ebbed to the lower 1.1800s from levels above 1.1850. USD-JPY lifted to a five-day high at 104.98. Cable dipped briefly below 1.3000 for the first time since last Wednesday. The pound also traded modestly softer against the euro and other currencies, remaining comfortably within recent ranges. The EU's trade envoy, Barnier, and his team have extended their time in London through to this Wednesday as intensive talks on the future relationship continue. Brandon Lewis, a senior member of Boris Johnson's cabinet, said yesterday that "there is a good chance we can get a deal." Elsewhere, commodity prices are lower, and front-month WTI oil futures in particular dropped about 3% in posting a three-week low at $38.42. This helped lift USD-CAD to a six-day high at 1.3184. The U.S. elections are now just eight-days away.

    [EUR, USD]
    EUR-USD ebbed to the lower 1.1800s from levels above 1.1850. Once again, the directional shift has been driven by the dollar, which lifted today as global stock markets turned lower. Real interest rate and real yield differentials are moderately, but mechanistically, bullish for EUR-USD, while last 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 last week also showed a rise in the Eurozone's current account surplus. Markets are additionally 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, 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. Ireland and Wales are in full national lockdowns, while Spain has announced a state of emergency. 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 lifted to a five-day high at 104.98, though the pair still remained down by about 0.5% from week-ago levels following the sharp drop that was seen last Wednesday. Japanese inflation data last week 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, but mechanistic negative for the nominal USD-JPY rate. In other data, Japan preliminary October PMI, also released last week, 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 partly reflects the relatively aged demographic in Japan. Both Japan and China are 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 dipped briefly below 1.3000 for the first time since last Wednesday. The pound also traded modestly softer against the euro and other currencies, remaining comfortably within recent ranges. The EU's trade envoy, Barnier, and his team have extended their time in London through to this Wednesday as intensive talks on the future relationship continue. Brandon Lewis, a senior member of Boris Johnson's cabinet, said yesterday that "there is a good chance we can get a deal." Despite the recent stand-off between the UK and some EU leaders (France, for instance, threatening to veto an agreement if it doesn't get want it wants) it has been increasingly evident that both sides are set on reaching an accord. There is a sense that the backdrop of surging new Covid cases has helped realpolitik break out on both sides of the channel. On Friday a Reuters article, citing French fishing industry sources, said that Macron's government have warned them to expect a smaller catch. France has been the most vocal of the so-called coastal 8 EU nations that have been demanding unchanged access to UK waters for fishing, which has been the principal sticking point in trade talks, so the Reuters report is significant, revealing that a compromise appears to be in the works. The UK, meanwhile, signed its first post-Breixt trade deal on Friday, with Japan, a deal which was agreed in principle a month ago. With a no deal scenario now looking much less of a risk, the question now is more focused on how limited or how broad a deal might be between the EU and UK. The consensus is for a narrower rather a broader deal, and we concur with this. But, it should also be considered that the EU and UK might conceivably surprise 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 feasible. Even some Brexit ideologues in the UK have suggested that maintaining close alignment with EU rules -- for now -- may be the more pragmatic way forward given the Covid stresses, before diverging from EU rules in an evolving process over time.

    [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 rallied to a six-day high at 1.3184, floated by a broadly firmer U.S. dollar and more especially by a sharp drop in oil prices. Front-month WTI crude futures dove about 3% in posting a three-week low at $38.42. USD-CAD has been trending lower since March, though we have been noting trend derailing risks stemming from draconian Covid-related measures as the northern hemisphere heads into winter, which is crimping global growth and, with it, demand for oil.

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