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By XE Market Analysis September 1, 2020 4:15 am
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    XE Market Analysis: Europe - Sep 01, 2020

    The dollar weakening theme continued into the London interbank open today. The narrow trade-weighted USD index (DXY) fell to a new trend low at 91.78, a level last seen in April 2018. The dollar, by this measure, is down by nearly 11% from the near four-year high that was seen back in March. Bearishness about the U.S. currency abounds, especially in the wake of Fed Chairman Powell confirmation last week of the framework regime shift at the FOMC (which was generally expected, but the timing of the announcement came earlier than most had been anticipating). The shift means lower-for-longer with regard to interest rates. Negative real rates in the U.S., and this year's sharp narrowing in Treasury yields versus foreign counterparts, along with stronger relative growth differentials globally, are being cited in market narratives. Concerns about U.S. finances is also getting a mention, although the same could be said about many other countries given the colossal cost of global lockdowns. The Fed policy shift and a decline in the dollar will also chime with the policy objectives of the Trump administration, in so far as it loosens financial conditions, raises profits for U.S. exporters and reduces trade imbalances. Globally, a weaker dollar will also cheapen the servicing of dollar denominated debt in many developing economies, whose currencies mostly dropped sharply versus the dollar as a consequence of the pandemic. Inevitably, the "end of the dollar is nigh" (as the world's reserve currency) narrative is getting a dusting down. Improved euro sentiment is also in the mix, with the 750 bln euro recovery fund seen as having reduced Eurozone breakup risks while creating a new triple-A attraction for global investors. The latest CFTC data showed net dollar short positions were at the most extreme in 10 years, and a BoA Global Research survey found 36% of the fund managers said that shorting the dollar was their top currency trade for the second half of 2020. Trend following seems prudent for now. A concurrent theme is yen weakness (outside the case of USD-JPY). The EUR-JPY and AUD-JPY crosses, for instance, pegged respective 16- and 18-month highs yesterday.

    [EUR, USD]
    EUR-USD has posted a 28-month high at 1.1998 on the back of continued dollar weakness. EUR-JPY has been rising, too, with the cross yesterday printing an 18-month high at 126.87, which mostly reflected yen weakness with the common currency trading mixed versus most other currencies. EUR-USD is on course to make this the thirteenth up week that's been seen out of the last sixteen weeks. The framework regime shift at the Fed, announced by Chairman Powell last week, effectively reaffirmed the dollar softening trend, concomitantly with shorter dated inflation-adjusted Treasury yields posting fresh lows. Improved euro sentiment is also in the mix, with the 750 bln euro recovery fund seen as having reduced Eurozone breakup risks while creating a new triple-A attraction for global investors. Going with the trend looks the best strategy for now. But, there are forces that may weaken this trend. One is that incoming U.S. data has been showing ongoing economic recovery in the U.S. Another is that the ECB is also considering average inflation targetting with the aim of increasing inflation expectations, which would presumably weigh on the euro. The Eurozone's economic recovery may also flatten as a consequence of renewed restrictions for hospitality and travel operators. This was the prime cause for preliminary August services PMI surveys missing consensus expectations. Governments in most European countries (Sweden being the main exception) remain somewhat trigger happy in imposing localised restrictions in response to upward flurries in positive coronavirus tests -- even though there hasn't been any significant correspondence of actual public health events (serious illness and associated hospitalisations and deaths). The death rate from all respiratory illnesses outside Covid-19 has been greater than for Covid itself for some time now, and all-cause mortality rates continue to trend below long-term averages. Most media outlets are not reporting this, and remain resolutely focused on new cases, maintaining the 'feardemic' and consequential panicky government responses.

    [USD, JPY]
    USD-JPY drifted moderately lower on the back of broader dollar weakness, while the yen has remained soft against most other currencies. AUD-JPY remained buoyant after posting a 16-month high at 78.47 yesterday. Ditto for EUR-JPY, which yesterday printed an 18-month high at 126.87. GBP-JPY rallied into seven-month high terrain yesterday, since consolidating. Most yen crosses have been trending higher since May, with the Japanese currency tracking inversely with global stock market direction. The yen is likely to remain apt to directional change on the back of shifting risk premia in global markets. Backed by a surplus economy, and one where yield-seeking domestic investors are apt to invest in foreign assets during times of confidence, but repatriate funds when times are uncertain, the yen has a profile of being a low-beta haven currency. With risk appetite among market participants high, fuelled by massive monetary and fiscal stimulus efforts worldwide, the yen has been trending lower (ex USD-JPY). This looks likely to remain the case for now.

    [GBP, USD]
    Cable has risen above the 1.3400 level for the first time since last December. The has continued to be floated by broad dollar weakness. GBP-JPY has also been lifted by yen weakness, which saw the cross print seven-month highs yesterday. The pound has fared less well against the euro and other currencies. Markets continue to take a sanguine view of the apparently stalled progress in trade talks between the EU and UK. All things Brexit go down to the wire, and expectations for any real progress are low until much nearer the deadline, which is widely accepted as being the EU's leaders' summit in October. The consensus view is that a deal will be struck. We are wary. There are grounds to doubt there can be anything other than a narrow deal, given the intransigence on the EU's level-playing-field rules and fishing rights. A bear-bones deal or a no-deal outcome are a risk. Prime Minister Boris Johnson's cabinet is full of Brexit ideologues; of the view that Brexit is an opportunity to craft the UK on the Singaporean model, as an outwardly-oriented, low-tax and pro-trade hub. Signing up to the EU's level-playing-field rules is not consistent with this view, and there is only so far that the EU is likely to bend. The government, which has over four years on the electoral clock and a large majority in parliament, is in a position to weather short-term economic damage that leaving the EU's single market without a comprehensive new trade deal would cause. Note that when UK leaves the single market, it will not just be leaving free trade with the EU but also the 40 free trade deals the EU has across the globe. Another downside risk for the pound is that the UK government's pandemic-era furlough scheme will end in late October, which is likely to cause an upward jolt to the unemployment rate, with the aviation, high street retail and hospitality sectors to be hard hit. The wage support scheme protected about 9.5 mln jobs at the height of the lockdown, though there remains up to 1.5 mln jobs at risk of being chopped in October, unless the government extends its support scheme (as Germany did with its plan last week).

    [USD, CHF]
    EUR-CHF has settled back to narrow range trading in the 1.0750-1.0800 range, having failed to sustain recent forays above 1.0800. The influence of the SNB's intervening hand may have been at play during the recent upside bursts. Total Swiss sight deposits of francs have risen by over 130 bln since the pandemic and consequential lockdowns took a grip on global markets back in March. Sight deposits can be viewed as a proxy marker of SNB intervention to sell francs in forex markets (after buying foreign currencies), which results in the crediting of newly created francs at commercial banks sight accounts. The rise in sight deposits also reflects SNB operations to boost liquidity via the COVID-19 refinancing facility. The advent of the EU's recovery fund, seen as a milestone by many analysts (a new liquid AAA fund that also reduces Eurozone breakup risks) has by many accounts caused a re-weighting of the common currency in portfolios, and which should help the SNB combat what it sees as a chronically overvalued franc. EUR-CHF still remains below the seven-month peak that was seen in early June at 1.0921.

    [USD, CAD]
    USD-CAD has dropped below the 1.3000 level for the first time since early January, driven lower by a weakening U.S. currency. Oil prices have continued to trade neutrally, holding below the six-month highs that were printed last week. (Hurricane Laura wasn't as disruptive to Gulf of Mexico crude production as feared), so the latest phase of decline in USD-CAD is a weak U.S. currency story. The pair only needs to fall below last December's nadir at 1.2949 to put it in 23-month low territory. We advise trend following.

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