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By XE Market Analysis October 16, 2020 7:13 am
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    XE Market Analysis: North America - Oct 16, 2020

    The dollar and yen continued to hold firm, although both softened as European stock markets and U.S. equity index futures rose moderately. There remains a tremulous vibe in global markets in the face of a plethora of risks -- billowing new Covid cases, especially in Europe, and associated trend toward increasingly stringent countermeasures, an increasingly bleak near-tern outlook for a much-needed fiscal stimulus package in the U.S., the risk of the upcoming U.S. election being contested, and the drama of the climaxing Brexit endgame. Trade tensions between China and Australia have been getting mention in some market narratives, too. ABC news cited Australian government source saying that Beijing is considering imposing a 40% tariff on Australian cotton imports, which would render trade in with China in this area unviable. This follows reports that China is set ban imports of Australian coal, although this seems at least in part a reflection a secular decline in demand for coal. Regardless, both coal and cotton are fungible, undifferentiated products, and China's antics should not pose much threat to Australia's terms of trade. The Australian dollar is heavy, but has remained above yesterday's lows against the dollar and yen, among other currencies. Elsewhere, the USD index (DXY) has ebbed moderately after posting a nine-day peak at 93.98. EUR-USD lifted to the lower 1.1700s after pegging a 16-day yesterday, at 1.1688. USD-JPY has continued to ply a narrow range in the lower-to-mid 105.00s. The yuan has continued to hold steady after dropping about 0.5% earlier in the week. The pound dropped quite sharply yesterday from levels above 1.3000 against the dollar, and edged out a two-day low at 1.2883 earlier today before recouping back above 1.2900. Boris Johnson yesterday gave the EU 24 hours -- coinciding with today being last day of the EU summit -- to back down on its demands for unchanged fishing rights in British waters. The EU has offered to extend talks for another two weeks. Johnson is due to make an announcement at noon today.

    [EUR, USD]
    EUR-USD has settled not far above yesterday's 16-day low at 1.1688. Data showed the Eurozone trade surplus expanded to EUR 21.9 bln on a seasonally adjusted basis in August, from EUR 19.3 bln in the previous month, while Eurozone HICP inflation was confirmed at -0.3% y/y in the final reading for September. Both of these are in isolation and in conventional analysis positive for the euro versus the dollar, the former contrasting the U.S. deficit, the latter contrasting with the current U.S. headline CPI rate of 1.4% y/y (tightening in real interest rates in the eurozone versus a loosening in real interest rates in the U.S.). There are, however, a number of countervailing influencers which have been weighing on EUR-USD. One is the prevailing wariness among global market participants, which gives rise to capital being safe harboured in U.S. Treasuries. While we are would-be dollar bears, this is hinged on the global growth outlook establishing a sustainable improving trend, and that in turn is hinged on the world getting through the Covid crisis. The world perhaps may also want to get on the other side of the upcoming U.S. elections, given the concerns of the election being contested and the prevailing political balance failing to produce a much-needed fiscal package. Brexit risks have also become a pressing consideration with regard to the common currency (more acutely in the case of the pound), while the recent salvo of dovish signalling from ECB policymakers has contributed in offsetting the dollar's weakening bias. On balance, we remain bearish on EUR-USD at this juncture.

    [USD, JPY]
    USD-JPY has continued to ply a narrow range in the lower-to-mid 105.00s, above the two-week high that was set earlier in the week at 105.04. The yen has remained firm against most other currencies, although off highs seen yesterday for the most part. Chinese JGB purchases were reportedly a factor that underpinned the yen earlier in the week. Japanese data this week included a record 7.4% y/y rise in money supply as measured by M3, which is the broadest money aggregate. Not exactly a market mover, but given negative core inflation in Japan is illustrative of the chronic liquidity funk the Japanese is in. At the same time, Japan's negative inflation print has a mild tightening impact on real interest rates. This contrasts to the loosening trend in the U.S. real interest rate, and the differential between the two is a structural negative for the nominal USD-JPY exchange rate (albeit modest). The biggest directional force on the Japanese currency will, however, remain 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 long-established profile of a low-beta haven currency.

    [GBP, USD]
    The pound dropped quite sharply yesterday from levels above 1.3000 against the dollar, and edged out a two-day low at 1.2883 earlier today. Boris Johnson yesterday gave the EU 24 hours -- coinciding with today being last day of the EU summit -- to back down on its demands for unchanged fishing rights in British waters. This appeared to have been in response to signs that the EU called Johnson's bluff, with EU leaders dropping a pledge to "intensify" negotiations with the UK (the intended signal being that they are readying for a no deal). Johnson's initial "deadline" has already passed, and today is essentially his second deadline. The magnitude of the pound's loss would likely be much greater if markets were putting greater weight on Johnson's threat. On fishing, the two sides face a choice between a win-win and a lose-lose outcome, even if win-win means making concessions, so presumably it's not reasonable to expect a deal can be made. The EU has offered to extend talks for another two weeks. The stakes are enormous, especially for the UK, both economically and politically -- think border and travel chaos (admittedly these would be temporary), surge in food prices in the UK and plunge in terms of trade, including a big hit to the UK's service sector, alongside the existential threat to the integrity of the UK and an unwelcome return of a hard Irish border. Consideration of these issues is why we anticipate a deal, albeit a limited one. Reaching a deal would mean Johnson disappointing the powerful ERG faction of his party, and Spain, France and UK making concessions on fishing. Any news of a deal would likely boost sterling over the near term (or an agreement to extend talks for another couple of weeks), but even with a deal, and even with the UK's progress in signing continuity agreements with non-EU trading partners, the UK will see its terms of trade position deteriorate.

    [USD, CHF]
    The Swiss franc has been continuing to trade with a firming bias, consistently rebounding from bouts of weakness in recent months. This has seen EUR-CHF repeatedly ebb back from brief forays above 1.0800, and the cross has fallen to the lower 1.0700s in the latest phase as markets anticipate revamped monetary easing measures from the ECB. This along with Brexit risk, which has been weighing on the euro. The franc has a proclivity to ascend on the influence of incoming interest and other domestically owned investment receipts from assets held abroad, alongside net inflows generated by Switzerland's trade surplus. A higher franc has been imparting deflation, which to a degree offsets any loss in export competitiveness that a nominally firmer currency might otherwise entail as there is a high import component in the production of Swiss exports (perpetuating the nominal trend by limiting the decline in the real effective exchange rate). The SNB, nonetheless, explicitly targets the exchange rate as one of the means to achieve its policy goals. At its quarterly monetary policy review last month, the central bank stated 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 retreated to the lower 1.3200s after yesterday reaching an eight-day high at 1.3261. A sharp rebound in oil prices after an equally sharp drop was accompanied by a mirroring price action in USD-CAD. The pair continues to have scope to run higher over the near term given the risk-wary backdrop in global markets, which may both support the U.S. dollar and weigh on oil prices. The worry list includes: billowing new Covid cases, especially in Europe, and associated trend toward increasingly stringent countermeasures, an increasingly bleak near-tern outlook for a much-needed fiscal stimulus package in the U.S., the risk of the upcoming U.S. election being contested (although the polling trend in favour of Biden suggests this peril may at least be receding), and the drama of the climaxing Brexit endgame. On Canada's domestic front, rising positive Covid tests are becoming a problem as they are leading to economically disruptive restrictions, similar to Europe and parts of the U.S.

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