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By XE Market Analysis December 3, 2020 7:14 am
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    XE Market Analysis: North America - Dec 03, 2020

    The DXY dollar index posted a fresh 32-month low at 90.84. The index is amid its third consecutive down week, and the dollar has declined in four of the last five weeks. Global asset markets have come off the boil, and many market narratives are talking about the good news on Covid vaccines and the clearing political picture in the U.S. having been "priced in." December has a reputation for being a down month (albeit not so much in recent years), while the most recent BoA global fund managers' survey found that cash holdings at fund managers are now down to pre-pandemic levels. Investor sentiment hasn't turned negative, however (which in the event would support the dollar), and the big-picture view remains a potently bullish one, despite the challenging realities of the now and over the upcoming depths the northern hemisphere winter. The mix of global fiscal and monetary stimulus, low interest rates, potential for a significant consumer spending boom in a vaccine-assisted return to normalcy in 2021 (households saving has increased over the pandemic) should maintain a positive sentiment, overall. This, in turn, is a negative backdrop for the dollar, especially with the shift in FAANG stocks from massive outperformers to underperformers likely to sustain. The ingredients for an asset bubble are there, which may end in an eventual bust. One particular downward driver of the dollar came into sharp focus in EUR-USD's upside break on Monday, when the initial estimate for November eurozone inflation showed CPI at -0.3% y/y, which contrasts the relatively high inflation rate in the U.S. (at 1.3% y/y in October). The implication is that inflation is imparting a loosening impact on real interest rates in the U.S., and a tightening impact on real interest rates in the eurozone, which translates to higher nominal EUR-USD levels. The Fed's inflation tolerant, lower-for-longer policy rubric is a consideration here. Amid the main currency pairings today, EUR-USD lifted to a new 32-month peak at 1.2141. Cable logged a three-month high at 1.3441. AUD-USD posted a 24-month peak at 0.7436, and USD-CAD printed a 26-month low at 1.2905. USD-JPY continued to ply a narrow range in the mid 104.0s, with the yen weakening concurrently with the dollar against other currencies.

    [EUR, USD]
    EUR-USD lifted to a new 32-month peak at 1.2141, driven by broad dollar declines. EUR-JPY also rose to fresh three-month highs, but the common currency has otherwise been steady against most other currencies, and has declined against the pound. One particular downward driver of the dollar came into sharp focus in EUR-USD's upside break on Monday, when the initial estimate of November eurozone inflation data showed CPI at -0.3% y/y, which contrasts the relatively high inflation rate in the U.S. (albeit at only 1.3% y/y in October). The implication is that inflation is imparting a loosening impact on real interest rates in the U.S., and a tightening impact on real interest rates in the eurozone, which translates to higher nominal EUR-USD levels. In a zero percent interest rate world, this apparently matters in exchange rate determination, which may explain why the market discarded the notable widening in the U.S. 10-year yield versus the 10-year Bund yield. The market is factoring that recession-bound eurozone economies will maintain disinflationary pressures, with the ironic consequence of causing euro appreciation against the dollar, despite the disadvantageous growth differential between the eurozone and the U.S. Insofar that a higher euro will curb eurozone growth potential, a self-reinforcing process can be observed, though this may be an overstatement. Inflation will jump in the eurozone once as and when negative y/y base effects drop out of the equation. Raw material prices have been surging, too. There are other factors at work, one being the search for value in global markets as uncertainties dissipate (the two central ones being the clearing U.S. political picture, which is raising the prospect for new fiscal stimulus, along with the rapid progress in Covid vaccines), which are a dollar negative, especially with the FAANG stocks shifting to massive outperformers to underperformers. The Fed's inflation tolerant, lower-for-longer policy emphasis, along with the marked outperformance in European stock markets relative to global pe ers over the last month are other considerations, with European assets seen offering greater value opportunities in the vaccine-assisted view for a post-Covid return to economic normalcy. We retain a bullish view of EUR-USD.

    [USD, JPY]
    USD-JPY continued to ply a narrow range, with the yen weakening concurrently with the dollar against other currencies. EUR-JPY posted a fresh three-month high, and AUD-JPY a two-and-a-half-month high, for instance. Global asset markets have come off the boil after recent strong gains, though risk appetite hasn't turned negative. Regarding USD-JPY specifically, both currencies are viewed as safe haven, counter-cyclical currencies, which limits the direction scope for the pairing, though the real interest rate differential between the U.S. and Japan is a mathematical negative for the nominal exchange rate. Outside the case against the dollar, the yen is amid what we are tagging as a longer-term softening trend, especially against the cyclical currencies, including the dollar bloc. 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 recovered some of the lost ground seen yesterday, aided by the final November UK service PMI being revised higher, to 47.6 from 45.8, with business optimism in the sector rose to its best since February. Sterling has undergone some volatility over the last day, gaining on news that the UK government has approved the Pfizer-BioNTech Covid vaccine before dropping back on Brexit-related anxieties. Market participants were already well aware that the UK had set itself up to be first in line for vaccinations (given its rapid emergency approval process and having pre-ordered substantial quantities of all three leading vaccines, including the Moderna and AstraZeneca versions). There is also some caution about the down-to-the-wire Brexit endgame. EU chief negotiator Barnier yesterday warned EU states to be ready for a no-deal scenario, while France is reportedly playing hardball, signalling that Barnier should give up on negotiations and allow the UK to exit the common market and customs union without a deal. Our view is that this is likely a ploy, timed to coincide with the fast looming up deadline for the EU and UK to strike an accord and allow time for the ratification process. This Saturday is reportedly the deadline being worked to, though it's hard to be sure as this is the latest in a line of deadlines that have come and gone. There have been reports that the European parliament could convene as late as December 28 to ratify a trade deal. Regarding the French position, it has long been known that there are hawks in President Macron's administration who believe that it would better to negotiate with the UK "on the other side of a no-deal Brexit," on the view that the UK would then be much more pliable. Germany and many other EU states seem to be against this, so our view is that France will back down. Germany's Merkel has been putting pressure on EU states to compromise. The French have bad cop form on Brexit, having consistently threatened to veto the multiple extensions in last year's negotiation over the UK withdrawal agreement, only to back down with equal consistency. There are also reports that the UK has lowered its demands on fishing rights, and that progress has been made on state aid rules.

    [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 posted a new 26-month low at 1.2905. Oil prices have firmed back up over the last day after softening in recent sessions. The pause in the global asset market rally, along with non-OPEC Norway announcing that it will end self-imposed output restrictions at year end, and Libyan supply returning to pre-blockade levels, warrants caution for those bullish on the Canadian dollar and other oil correlating currencies. A Reuters article this week, citing sources, said that some members of the OPEC+ group are itching to lift output levels. The group on Monday delayed a decision on quotas for three days, until today. Notwithstanding the Reuters report, the market consensus is for the group to maintain prevailing quotas for another three months from January. A six-month extension is also being considered, which by OPEC's own analysis would likely swing the oil market back into supply deficit in 2021. 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 and non-OPEC output has increased, as mentioned above. 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 big-picture 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, though there are growing risks for a nearer-term rebound, and/or phase of consolidation.

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