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By XE Market Analysis October 28, 2020 5:28 am
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    XE Market Analysis: Europe - Oct 28, 2020

    The dollar and yen are higher on safe haven positioning, and bitcoin hit its best level in almost three years. U.S. Treasuries have remained underpinned as liquid capital seeks harbour, with the dollar holding up despite a 10bp drop in the 10-year T-note yield since last Thursday, which has seen the U.S. yield differential decline relative to peers, including the Bund. The dollar is also just over 1% up on gold over the last week in a further confirmation that the currency is functioning as a safe haven. U.S. and European equity markets are continuing to markedly underperform Asian counterparts, with the latter region faring much better with regard to the Covid situation. This has helped the risk-sensitive Australian dollar fare better than it perhaps would have otherwise. AUD-USD posted a 13-day high at 0.7157 before turning lower to near net unchanged levels. As for the U.S. dollar, the DXY index rose 0.3% in pegging an eight-day high at 93.22, while EUR-USD concurrently dropped to a nine-day low near 1.1750. Cable fell by a near same magnitude in printing a two-day low at 1.3001. The pound has been holding steady against the euro. Talks between the EU and UK will continue in London today before relocating to Brussels tomorrow. They are reportedly working to a mid-November deadline. Market participants are cautiously optimistic that at least a narrow free trade deal will be reached, but still await concrete news that the two sides have reached a breakthrough on the key sticking points. Yen outperformance tilted USD-JPY lower, with the pairing hitting a five-week low at 104.17 in what is now the third consecutive week of decline. Given the yen's real interest differential advantage over the dollar, there is mathematical logic for weakness in the nominal dollar versus yen exchange rate. Elsewhere, a near 4% plunge in oil prices lifted USD-CAD to within a couple of pips of the 12-day high that was seen on Monday at 1.3226.

    [EUR, USD]
    EUR-USD dropped to a nine-day low near 1.1750, driven lower by broad dollar demand amid a risk-off positioning theme in global markets. EUR-JPY also dropped for the same reason, while the common currency has fared better against the pound and other European currencies. While last week's successful first joint EU offering of social bonds, which will finance a jobs program, attracted foreign capital and shored up the reputation of the euro, EUR-USD downside possibilities are becoming more pronounced on persisting risk aversion in global markets. This has boosted U.S. Treasury bond prices as liquid capital looks for a safe harbour, and a resulting narrowing in the U.S. yield differential advantage hasn't had a weakening impact on the dollar. Investors are facing 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 and France is reportedly on the verge of a national lockdown. Strong measures are also being taken 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. Of note, was data yesterday showing a sharp rise in September M3 money supply in the Eurozone as a consequence of ECB policy, but only a limited corresponding rise in loan growth while consumer credit rose by only 0.1% y/y -- a red flag with regard to the economic outlook.

    [USD, JPY]
    The yen has been on the ascent amid a risk-off positioning theme in global markets. Global stock markets have been tumbling, with U.S. and European equity markets markedly underperforming Asian counterparts, with the latter region faring much better with regard to the Covid situation. USD-JPY hit a five-week low at 104.17 in what is now the third consecutive week of decline. Given the yen's real interest differential advantage over the dollar, there is mathematical logic for weakness in the nominal dollar versus yen exchange rate. The dominant 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 fell by a near same magnitude in printing a two-day low at 1.3001. The pound has been holding steady against the euro. Talks between the EU and UK will continue in London today before relocating to Brussels tomorrow. They are reportedly working to a mid-November deadline. Market participants are cautiously optimistic that at least a narrow free trade deal will be reached, but still await concrete news that the two sides have reached a breakthrough on the key sticking points. Fishing appears to be the final stumbling block, but the signs are that a compromise will be reached in this area. 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, though it should also be considered that the EU and UK might conceivably surprise everyone with a much more comprehensive deal than is generally 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 crisis, before diverging from EU rules in an evolving process over time. The central criteria for the pound's future trajectory will be what impact any deal has on the UK's terms of trade. A narrow deal, which may limit free trade to goods and some services, would be negative for the pound over the longer term. A deal that would leave the UK closely following EU rules to begin with would likely spark a near-term rally in the pound, although even then it would likely mark a deterioration in the UK's trading position, with knock-on effects, including reduced investment and loss of productivity. The prospect of the BoE going negative on interest rates would increase, especially given economic-impacting Covid countermeasures in both the UK and across Europe, while declines in the pound would push real interest rates lower. The UK's current account deficit would decrease in this scenario, but at the price of declining capital inflows, and possibly a period of net capital outflows.

    [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 is on the rise amid a sharp drop in oil prices. Front-month WTI crude futures dove by over 4% in posting a three-week low at $37.92. Oil prices look likely to remain suppressed given the supply glut and weakening demand as Covid-containing measures intensify across Europe and some parts of North America. This backdrop should in turn 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 plausible.

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