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By XE Market Analysis November 6, 2020 7:40 am
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    XE Market Analysis: North America - Nov 06, 2020

    The dollar is down for a fourth consecutive day, with the DXY index posting a two-month low at 92.28 and EUR-USD rising to a 16-day high at 1.1878, extending the sharp rally from the 1.1603 low seen earlier in the week. USD-JPY printed a fresh eight-month low at 103.19. Expectations for a relatively lacklustre U.S. jobs report later have maintained momentum the dollar weakening theme. The pricing out of a Democrat sweep saw U.S. Treasury yields dive this week, due to the prospect of less issuance than would otherwise have been, while sparking a strong rally on Wall Street on the prospect for less tax and less regulation, which in turn ignited a risk-on positioning theme in global markets. This saw safe haven positions in the dollar unwind rapidly, while the decline in U.S. yield differentials versus other sovereign benchmarks has vectored continued declines in the U.S. currency. Markets are pricing in a Biden presidency and a split Congress, with Republicans likely to retain the Senate and with the Democrats retaining the House. As for the U.S. October payrolls report, markets are expecting the headline to show the lowest job gain in five months as a consequence of flagging momentum due to fiscal stimulus ending and new Covid restrictions being implemented in various parts of the country. The biggest gains out of the main currencies have been the dollar bloc and other commodity-correlating currencies. Most commodity prices are up strongly versus week-ago levels. Oil prices are up over 7%. The pound has been mixed this week, gaining on the dollar, holding near net unchanged levels versus the euro, while losing ground to the Australian dollar and other commodity correlators. EU trade negotiator Barnier said earlier in the week that "very serious divergences remain" with the UK, a message repeated by other officials. Judging by the performance of the pound, markets are evidently not perturbed, expecting a last minute climbdown.

    [EUR, USD]
    EUR-USD is up for a fourth consecutive day, this time posting a 16-day high at 1.1878. This extends the sharp rally from the 1.1603 low seen earlier in the week. The prevailing dollar down trend coupled with expectations for a relatively lacklustre U.S. jobs report later have maintained bullish momentum in EUR-USD. The pricing out of a Democrat sweep saw U.S. Treasury yields dive this week, due to the prospect of less issuance than would otherwise have been, while sparking a strong rally on Wall Street on the prospect for less tax and less regulation, which in turn ignited a risk-on positioning theme in global markets. This saw safe haven positions in the dollar unwind rapidly, while the decline in yield differentials versus bund yields and other sovereign benchmark yields vectored continued declines in the U.S. currency. Markets are pricing in a Biden presidency and a split Congress, with Republicans likely to retain the Senate and with the Democrats retaining the House. As for the U.S. October payrolls report, markets are expecting the headline to show the lowest job gain in five months as a consequence of flagging momentum due to fiscal stimulus ending and new Covid restrictions being implemented in various parts of the country. Bigger picture, the outlook for the dollar is bearish amid a relative weakening in capital inflows to the U.S., which are needed to fund the current account deficit. The demand for stimulus funding is strong in many world economies given the impact of the Covid pandemic, which draws capital away from the U.S. China may also be strategically downsizing the relative size of its Treasury holdings. Add to this the negative real interest rates and yields in the U.S. and the Fed's lower-for-longer monetary policy rubric. As for EUR-USD, there are some countervailing forces (to the weakening dollar scenario) at play, including the Covid restrictions in Europe, along with the ECB's intensified dovish lean, which has featured an explicit mention of the exchange rate, given the undesired tightening effect of an ascending euro on real interest rates in the Eurozone.

    [USD, JPY]
    USD-JPY has broken lower this week on a yield differential dynamic, with the 10-year T-note yield differential over the 10-year JGB yield dropping by about 14-15 bp from levels seen ahead of U.S. election results on Tuesday, even allowing for the 3bp-plus lift out of lows. Taking into account the 1%-plus inflation rate in the U.S. and the currently negative inflation rate in Japan, and the impact on the real yield differential is slightly magnified. USD-JPY has been trending steadily lower since June from levels above 109.00 with a fairly steady momentum. The 10-year real constant maturity Treasury yield has concomitantly declined over this period, and at the most recent indicated level of -0.86% (from yesterday) is exactly 50 bp down on the peak seen on June 4th, and is down by 94 bp from the 2020 opening level on January 2. The real 10-year JGB yield has been comparatively steady over this time, and the diverging differential has been imparting a downward force on the nominal exchange rate between the dollar and yen. USD-JPY's break below 104.00 triggered stop loss and option-related selling, according to market narratives, which helps explain the yen's decoupling from its usual inverse correlation with global stock market performance this week, although the Japanese currency is still registering modest declines versus the euro and dollar bloc currencies. The pair extended lower today, posting a fresh eight-month low at 103.19 to mark a near 5% decline on the year so far.

    [GBP, USD]
    The pound is up on the dollar and moderately up on the euro after some whippy price action in the wake of the BoE announcement. The BoE expanded gilt purchases by by 150 bln pounds -- 50 bln more than markets had been anticipating. Despite this, gilt yields have risen, with the differential over Bunds widening a little. Markets welcomed the BoE's more aggressive than anticipated increase in stimulus, which has helped feed the prevailing risk-on theme in global markets. The rise in sterling has seen shares of large cap, export oriented UK underperform European peers, while shares of smaller cap, domestically oriented UK companies have performed strongly. Cable, assisted by a generally softer dollar, rallied by over 0.6% in posting a high at 1.3075, while EUR-GBP dove some 60 pips to a 0.9006 low in the wake of the BoE announcement before settling higher, around the 0.9040-50 area. The BoE left the repo rate unchanged at 0.1%, as had been widely expected, while signalling it is ready to expand asset purchases again, if necessary. The BoE stressed that the outlook remains "unusually uncertain," dependent on the evolution of the pandemic and measures taken to protect public health, alongside the nature of, and transition to, the UK's new trading relations with the EU. The BoE expects GDP to lift in the first quarter of 2021 on the proviso that Covid restrictions loosen and that there is a free trade agreement with the EU in place on January 1, which is when the country exits from the common market and customs union. The central banks sees inflation lifting in the new year as the impacts of a sales tax cut and energy price declines dissipate. On the Brexit front, EU negotiator Barnier raised eyebrows yesterday by stating that "very serious divergences remain." Judging by the performance of the pound, markets are evidently not perturbed, expecting a last minute climbdown. The final deadline is understood to be the end of next week.

    [USD, CHF]
    EUR-CHF has lifted back above 1.0700 after foraying below this level following recent declines in the euro, with the ECB levelling-up monetary accommodation. The ECB's policy course has been in effect supplementing the Swiss currency's chronic firming bias by weakening the euro, with the EUR-CHF cross being a proxy of the franc's trade-weighted exchange rate. The franc has a fundamental underpinning rooted in Switzerland's strong balance of payments position, which features a large current account surplus to GDP. Switzerland also has the status of having the second highest GDP per capita in the world. While the SNB implements a punishing -0.75% deposit rate, real interest rates are still lower in the U.S. than they are in Switzerland, which is mathematically bearish for the nominal USD-CHF exchange rate, all else equal -- and albeit very modest. 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 settled above lows seen yesterday, which follows a near 2% decline this week. The pair saw some relatively extreme price action during the week, but the net outcome has been weaker U.S. dollar and firmer commodity-correlating currencies, including the Canadian dollar. The pricing out of a Democrat sweep in the U.S. elections caused U.S. Treasury yields to dive, and generated a rally on Wall Street and global stock markets given implications for less tax and less regulation than there would otherwise have been, which is typically a potent recipe for a bullish stock market. WTI benchmark oil prices are showing a gain of over 13% from the low seen on Monday, ahead of the U.S. election, though remain down by nearly 8% from the highs that were seen a couple of weeks ago, before the likes of German and France announced they were heading back into lockdowns. There has been a realization among investors that the lockdowns in Europe are in the main much less restrictive than they were the first time around, which has seen some position adjusting to reflect a less pessimistic view than hitherto seen. October employment reports are out from both the U.S. and Canada today. Both are expected to show a picture of flagging momentum in job growth. New Covid restrictions and the end of fiscal stimulus in the U.S. are to blame. Investors have reason to look across the valley to brighter pastures, with new U.S. stimulus to be expected once the election results are sorted, and with the many leading candidate Covid-19 vaccines showing good results in advanced-stage testing. We anticipate USD-CAD's bear trend, which has been unfolding since March, to remain intact.

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