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By XE Market Analysis December 2, 2020 7:12 am
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    XE Market Analysis: North America - Dec 02, 2020

    The dollar and yen have remained soft versus most other currencies, although caution emerged in global asset markets. EUR-USD broke higher over the last day and today extended to a new 32-month high at 1.2089. Demand for euros was notable yesterday, and followed eurozone inflation data for November that came in below expectations in posting a fourth consecutive month of deflationary CPI readings, at -0.3% y/y. This marks a tightening in real eurozone interest rates, which contrasts to the pronounced negative real interest rate picture in the U.S., reflecting divergent inflationary pictures in the eurozone versus U.S. The last U.S. CPI headline for October was 1.2% y/y. In a zero percent interest rate world, this apparently matters in exchange rate determination, which may explain why markets discarded the 7bp-plus widening in the U.S. 10-year yield versus the 10-year Bund yield yesterday. The market is factoring that recession-bound eurozone economies will maintain disinflationary pressures, with an ironic impact of causing the euro to firm. The Fed's inflation tolerant, lower-for-longer policy emphasis is another consideration, along with the marked outperformance in European stock markets relative to global peers over the last month, with European assets seen offering greater value opportunities in the vaccine-assisted view for a post-Covid return to economic normalcy. Elsewhere, the pound declined against most currencies, having more than given back short-lived gains that were seen news that the UK government has approved the Pfizer-BioNTech Covid vaccine. Cable posted a high at 1.3441, which matched yesterday's three-month peak, before dropping back to the mid 1.3300s. The yen, meanwhile, remained in the underperforming lane of currencies. USD-JPY was buoyant, rising above 104.50 and bumping up on Tuesday's 104.58 high, while EUR-JPY saw a fresh 12-week high and AUD-JPY posted a two-and-a-half month peak. USD-CAD has posted a new 26-month low at 1.2914.

    [EUR, USD]
    EUR-USD has extended a three-month high at 1.1977, floated by dollar weakness. The U.S. currency has come under pressure against metals (copper hitting seven-year highs, aluminium 2-year highs) and Bitcoin and other crypto currencies, has seen a 32-month low against the New Zealand dollar, and a three-month low versus the Australian dollar. There seems real momentum behind the move, and prospects for EUR-USD to break above the 31-month high seen in August at 1.2024 look good. While there doesn't appear many strong prevailing reasons to bullish on the euro (recession bound eurozone nations, strong dovish bias at the ECB, the 750 bln euro EU recovery fund being delayed by a disputed with Poland and Hungary), European stock markets have outperformed global peers notably in November. We have been anticipating the euro gaining versus the dollar and yen while underperforming against more cyclical currencies on the view that risk appetite is likely to hold up in the months ahead, given optimism for a vaccine-facilitated return to economic normality in 2021, or something approaching it, alongside massive liquidity from world central banks, low inflation, and ongoing QE programs that force investors to search for the higher returns to be had in global equity markets. Negative real interest rates in the U.S. and the Fed's codified lower-for-longer policy rubric are considerations, as are the U.S. deficits and capital seeking higher returns in buoyant global markets.

    [USD, JPY]
    USD-JPY ebbed to a four-day low at 103.91. The yen was concurrently steady versus the euro and the pound, but posted respective two- and four-day lows against the Australian and Canadian dollars. A risk-cautious sentiment in global markets was a factor in the dollar bloc softening, while the real interest rate differential between the U.S. and Japan is also a mathematical negative for the nominal dollar vs yen exchange rate. Both the dollar and yen are still being viewed as safe havens, too, which may limit the magnitude of USD-JPY directional change. Outside the case against the dollar, the yen is amid a longer-term softening trend, especially against the cyclical currencies, including the dollar bloc. BoJ Governor Kuroda pledged more stimulus earlier in the week, dependent on there being increased economic impact from Covid countermeasures. The yen's broader performance should continue to derive from the level of risk appetite 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, has established the yen as a low-beta haven currency.

    [GBP, USD]
    The pound has declined against most currencies, having more than given back short-lived gains that were seen news that the UK government has approved the Pfizer-BioNTech Covid vaccine. Cable posted a high at 1.3441, which matched yesterday's three-month peak, before dropping back to the mid 1.3300s. Selling into gains seems the prudent tactical move given, 1, market participants being well aware that the UK had set itself up to be first in line for vaccinations, have pre-ordered substantial quantities of all three leading vaccines, including the Moderna and AstraZeneca versions, and 2, the lack of a breakthrough in down-to-the-wire EU-UK trade negotiations. Many market participants are in a state of non-commitment, waiting on concrete developments from the ongoing negotiations between the EU and the UK. Yesterday had last week been touted as the deadline in EU-UK talks, but now the latest deadline is reportedly this Saturday, while there have been reports that the European parliament could convene as late as December 28 to ratify a trade deal. Germany's Merkel has been putting the pressure on EU states to compromise. Despite the negotiations dragging on, market participants are so far refraining from pricing in a no-deal outcome, as evidenced by the stability of the pound. Some political pundits have been arguing that there is a risk that the only way forward may be a no-deal -- which in the event would in effect mean that a deal is delayed, at the price of near-term logistical chaos and with what the OECD warned yesterday would be a "serious" economic hit. What is clear, deal or no deal, is that EU and UK's relationship will be an ever evolving and complicated one when the UK exits its transition membership of the common market and customs union at year end. The UK wants to diverge from EU rules, while EU states are concerned that the UK will undercut their markets. The relationship will be subject to dispute arbitration with the possibility of retributive measures. This is why markets are anticipating only a narrow free trade deal, which would be centred on manufacturing.

    [USD, CHF]
    EUR-CHF rallied to three-month highs above 1.0850, extending recent gains from sub-1.0700 levels. Recent risk-on positioning has been weighing on the Swiss franc with investors factoring in a sea change in optimism about a vaccine solution to the Covid-19 crisis. This will be pleasing to policymakers at the SNB, given their chronic disquietude about the franc's value. Unlike most central banks, the SNB explicitly incorporates the franc into monetary policy to ward off speculative purchases of the currency, which would impart deflationary forces (via cheaper imports) with the consequential impact of an unwelcome tightening in real interest rates. The central bank stated at its last quarterly monetary policy review that the franc remains "highly valued" and said it is ready to "intervene more strongly in the foreign exchange market."

    [USD, CAD]
    USD-CAD has dropped back under 1.2950, pulling lower from yesterday's rebound high at 1.3010, which was seen after the pair posted a 26-month low at 1.2922. The oil market will remain the dominant driver of USD-CAD, and we remain bullish of both oil and the Canadian dollar. Oil prices are up today after ebbing moderately over the previous few days. Strong Chinese manufacturing data boosted oil and other resource commodities. The OPEC+ group deferred a decision on output quotas until Thursday. The consensus expectation is for the group to refrain from rising output quotas for at least another three months from January, while a six-month extension is also being considered, which by its own analysis would likely swing the oil market back into supply deficit. Global stockpiles are high and demand for oil is set to be well below normal through the northern hemisphere winter due to Covid countermeasures, which are already tight in Europe and becoming more restrictive across North America and in the more northerly Asian countries. At the same time OPEC output has increased, with Libyan production having fully returned to pre-blockade levels. There is also a view that after the Covid pandemic has gone, oil will have a more elastic characteristic, with many developed nations likely to see a higher prevalence of working from home than before, reducing demand for fuel and enabling consumers of gasoline to reduce commuting days during times of oil high prices. These are motivating reasons for oil producing nations to keep supply restrained. Assuming quota discipline is maintained, the outlook is bullish for oil on the back of the increased optimism for a vaccine-assisted route out of the prevailing Covid situation. Consumers have built up savings and there is potential for a significant acceleration in global economic activity by mid next year. USD-CAD has been trending lower since March, and we anticipate there is more to come.

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