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By XE Market Analysis October 27, 2020 4:56 am
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    XE Market Analysis: Europe - Oct 27, 2020

    The dollar firmed up into the London open and beyond, paring declines seen earlier in pre-Europe trading in Asia. The move drove gold and oil prices lower, too, indicating there has been some depth in dollar buying, although the magnitude of movement hasn't been great. U.S. equity index futures have managed modest gains after the S&P 500 closed with a 1.9% loss yesterday, though investor sentiment in global markets remains decidedly restive. Most Asian stock markets declined, and Australia's ASX 200 equity index closed with a 1.7% loss in its worst single day performance in a month. Soaring positive Covid tests and the associated trend toward increasingly restrictive countermeasures, along with the risk of next week's U.S. election results being contested, and delay in U.S. stimulus relief, are keeping markets on edge. Overall strong Q3 economic data are being overlooked as markets look to what is appearing to be a grim winter ahead in the northern hemisphere, with risks of a double dip recession being factored, especially in Europe. Amid this, the dollar has been holding up, despite a narrowing in nominal U.S. yields relative to peers in recent days, including Bunds and JGBs, revealing that the U.S. currency is functioning as a safe haven currency again. The DXY index lifted back above 93.0, though remains down on yesterday's and Friday's highs at 93.11-13 highs. EUR-USD tipped back to levels around 1.1800 after posting a high at 1.1836. USD-JPY remained settled in the upper 104.00s in what could be termed a consolidation of the steep decline seen last Wednesday. The pair remains about 0.7% down from week-ago levels. Sterling continued to trade without direction, overall. EU and UK trade talks continue in London through to tomorrow before relocating to Brussels. They are reportedly working to a mid-November deadline. Taking a step back, the currencies that are showing the biggest gains on the year-to-date are the ones that most would expect to have risen against the backdrop of the global pandemic crisis, being currencies of current account surplus economies, specifically ones that don't have a high commodity export component. Thereby the euro, Swiss franc, yen are the biggest gainers, while the dollar bloc and the likes of the South African rand and Russian ruble, among others, are showing the biggest year-to-date declines.

    [EUR, USD]
    EUR-USD tipped back to levels around 1.1800 after posting a high at 1.1836. 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, EUR-USD 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 is in a full national lockdown, while Spain has announced a state of emergency. Strong measures are also being taken in France, Italy, and Germany, among other nations. 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 has settled in the upper 104.00s in what could be termed a consolidation of the steep decline seen last Wednesday. The pair remains about 0.7% down from week-ago levels. While the 10-year U.S. versus Japan yield spread has narrowed by about 6 bp since Friday, real interest rate and real yield differentials remain lower in the U.S. than in Japan, given the 1%-plus inflation rate in the former versus the near zero inflation rate in Japan. 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]
    The pound has been directionally mixed so far this week. There remains cautious optimism that the EU and UK are heading to a trade deal. EU and UK trade talks continue in London through to tomorrow before relocating to Brussels. They are reportedly working to a mid-November deadline. Boris Johnson welcomed the fact that talks on legal texts are underway for the first time, while Brandon Lewis, a senior member of the UK cabinet, said that "there is a good chance we can get a deal." It is understood that Germany's Merkel and other EU heads of state are putting pressure on France to compromise on its demand for unchanged access to UK waters for fishing. The UK wants a Norway-like agreement on fishing, where quotas are agreed annually, which most EU states see as reasonable. While France has threatened to veto an agreement if it doesn't get want it wants, a compromise seems to be in the works, with a Reuters article late last week citing French fishing industry sources saying that Macron's government have warned them to expect a smaller catch. 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 Covid, before diverging from EU rules in an evolving process over time. Near term there directional risk for the pound is skewed to the upside, but longer term the risks are skewed to the downside.

    [USD, CHF]
    The Swiss franc has been trading with a firming bias, consistently rebounding from bouts of weakness in recent months and briefly driving the EUR-CHF cross to levels under 1.0700 for the first time in three months. Markets are anticipating revamped monetary easing measures from the ECB while factoring in Brexit risk. The franc has a proclivity to ascend on the back of its balance of payments position. The SNB stated at its quarterly monetary policy review last month that the franc remains "highly valued" and said it is ready to "intervene more strongly in the foreign exchange market."

    [USD, CAD]
    USD-CAD lifted out of a correction low at 1.3169 with oil prices, although up yesterday's lows, coming under moderate pressure during the early London session. WTI benchmark crude prices are down 6.5% from week-ago levels, and prospects for a sustain rebound look to be limited given the supply glut and weakening demand as Covid-containing measures intensify across Europe and some parts of North America. This backdrop should keep USD-CAD underpinned. The pair has been trending lower since March, though we have been noting trend derailing risks. A run to levels around 1.3500 and above seems likely.

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