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By XE Market Analysis September 21, 2020 4:40 am
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    XE Market Analysis: Europe - Sep 21, 2020

    Dollar softness juxtaposed to yen firmness has been the dominant theme in currency markets so far today, which has been concomitant with tumbling global stock markets. USD-JPY dropped 0.4% in pegging a fresh seven-week lows under 104.20. Today racks up as the sixth straight trading day of decline, making this week the third consecutive week of decline. Yen crosses have also been on the ebb today, although by a lesser magnitude thus far. The narrow trade-weighted USD index (DXY) posted an 11-day low at 92.75, while EUR-USD concurrently posted a five-day high at 1.1873. The pound has gained on the dollar while losing ground to the yen. The commodity-correlating currencies have been holding up well, discordant to the risk-off backdrop in equity and commodity markets. There is a toxic mix of factors afflicting investor sentiment. There is a surging 'casedemic' in Europe (although which still cannot be called a pandemic given the remarkable lack of corresponding rate illness, hospitalisations and mortality), which is leading to much tighter restrictions and, in the case of the UK, the possibility of another full national lockdown. The approaching U.S. elections on November 3rd, characterized by ugly politicking with an outcome that is hard to call, with big implications for fiscal and other policies. The outlook for fiscal support measures globally is, overall, diminishing, and the pace of economic revival is flagging.

    [EUR, USD]
    EUR-USD posted a five-day high at 1.1873 on the back of broader weakness in the dollar. The dollar's down trend, which has been unfolding since late March (or mid May depending on how you define it) remains intact. Market participants are biased towards expecting further broad dollar declines. The Fed's regime shift, to deliberately stimulate inflation, and let it run higher than would have been possible under the previous rubric, is perceived by many as being structurally bearish for the dollar, with most peer central banks not having, formally at least, made this shift (the ECB and BoE are in process of reviewing their approaches). An upshot of Fed policy, and fiscal stimulus, this year has been to drive inflation-adjusted yields at the short-end through to the 10-year duration deep into negative territory. The 5-year real constant maturity T-note yield, for instance, hit a low of -1.41% on August 31st, and has since been flatlining around -1.27% to -1.29%. Then there is uncertainty about U.S. fiscal policy into the elections on November 3rd. These factors have undermined the dollar's role as a safe haven currency, while the dollar has been losing out to most other currencies during risk-on phases. But, dollar bears should tread carefully, as there are offsetting bearish factors affecting the euro. Not least is the surging coronavirus casedemic in Europe, which is prompting a phase of re-restrictions across the region (the UK government is even considering another full national lockdown). It has also become clear that most ECB policymakers, and not just the ones with dovish proclivity, are focused on the euro; the recent appreciation of which has counterbalanced, as ECB President Lagarde recently put it, some of the easing measures implemented during the pandemic.

    [USD, JPY]
    USD-JPY dropped 0.4% in pegging a fresh seven-week lows under 104.20. Today racks up as the sixth straight trading day of decline, making this week the third consecutive week of decline. Yen crosses have also been on the ebb today, although by a lesser magnitude thus far. The dollar's down trend, which has been unfolding since late March (or mid May depending on how you define it) remains intact. Market participants are biased towards expecting further broad dollar declines. The Fed's regime shift, to deliberately stimulate inflation, and let it run higher than would have been possible under the previous rubric, is perceived by many as being structurally bearish for the dollar, with most peer central banks not having, formally at least, made this shift (the ECB and BoE are in process of reviewing their approaches). An upshot of Fed policy, and fiscal stimulus, this year has been to drive inflation-adjusted yields at the short-end through to the 10-year duration deep into negative territory. The 5-year real constant maturity T-note yield, for instance, hit a low of -1.41% on August 31st, and has since been flatlining around -1.27% to -1.29%. Then there is uncertainty about U.S. fiscal policy into the elections on November 3rd. These factors have undermined the dollar's role as a safe haven currency. The dollar has also been losing out to higher beta global currencies during periods of rallying global stock markets and commodity prices. The ongoing correction in global stock markets, meanwhile, is supporting the yen. The Japanese currency 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 an established profile of a low-beta haven currency.

    [GBP, USD]
    The pound has gained on the dollar while losing ground to the yen. In the UK, coronavirus cases and corona-panic are surging. Localised lockdowns are now affecting 10 million people in the UK, and the government is set to announce further restrictions, including the possibility of a another full national lockdown, although that level of response is looking unlikely at this stage. This is a negative backdrop for the pound as it combines with the uncertainty surrounding the Brexit endgame, and with the minutes from the BoE MPC meeting last week affirming that the central bank is at full steam on contingency planning for negative interest rates (along with stressing that it is not ready to do so yet). Regarding Brexit, there is a view that PM Johnson has no intention of leaving the UK out of the EU's single market without a deal and reneging on the Withdrawal Agreement, given the significant economic and political damage it would entail. This view has been preventing the pound from seeing more extensive losses. We are inclined to agree with it, though it should be remembered that Johnson's cabinet is packed with Brexit ideologues, and the EU is simply not likely to accept the unilateral overwriting of the Withdrawal Agreement. One question whether is the EU is willing to accept the UK's Internal Market Bill (which contains legislation that overrides parts of the Withdrawal Agreement) as a bargaining chip (assuming the bill is fully ratified). The Brexit matter will be resolved by heads of state in the run-in to the EU's summit on October 15th-16th.

    [USD, CHF]
    EUR-CHF has plying a narrow range in familiar levels in the mid 1.0700s. The cross has repeatedly failed to sustain gains above 1.0800 over the last couple of months. 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. EUR-CHF still remains below the seven-month peak that was seen in early June at 1.0921. One downside risk for EUR-CHF is the Brexit endgame, which is fast approaching. The latest reports suggest the EU and UK are in a total impasse just one month before a deal has to be struck before the UK leaves the EU's single market at year-end. The risk is that the two sides will reach only a bare bones deal, or even no deal at all. The prospect for this would be de-stabilising for both the pound and euro, and would likely underpin the franc.

    [USD, CAD]
    USD-CAD has lifted to a four-day high at 1.3216, despite broad weakness in the U.S. dollar. A sharp drop in oil and other commodity prices has been weighing on the Canadian currency. Front-month WTI crude futures are down 2.2%, posting a three-day low at $40.37. Re-restrictions in Europe amid a surge in positive coronavirus test results, along with uncertainties into the November U.S. elections (which will have major implications on the course of U.S. fiscal policy, among other policy biases), have been generating a more cautious overall mindset among market participants. And while participants are seeing discordance in sky-high equity market valuations, particularly in the U.S., relative to evolving realities, they are also seeing some discordance in oil prices relative to the deteriorating outlook for demand, especially with news of a potential return to production of major oil producing facilities in Libya. The bearing down of another tropical storm on the Gulf of Mexico, which has for the third time this seasons caused the idling of facilities in the region, hasn't stopped oil prices from falling today. In sum, USD-CAD looks set for further gains, though shorting CAD-JPY would look the better route for those bearish on the Canadian dollar.

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