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By XE Market Analysis October 23, 2020 9:52 am
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    XE Market Analysis: North America - Oct 23, 2020

    The dollar fell back concomitantly with rallying European stock markets and U.S. index futures, which was likely a repositioning dynamic after declining over the last two weeks. EUR-USD rebounded quite strongly, rising back above 1.1850 from a three-day low at 1.1787. Preliminary October PMI data in the services and composite readings out of the Eurozone and UK undershot the median forecast of economists, but didn't impact the euro or sterling. Cable settled at near net unchanged levels around 1.3065-70 after dropping back from a high at 1.3114. The UK currency remains comfortably up on week-ago and month-ago levels against the dollar and euro, and others, with market participants anticipating a limited trade deal between the EU and UK. The two sides are amid intensive face-to-face discussions. The UK and Japan today signed the trade deal that was agreed in principle a month ago. USD-JPY is modestly softer after upside forays over the last day stalled at 104.93-95. At levels around 104.70, the pair remains down by 1% on the high seen on Wednesday. AUD-USD rallied to an eight-day high at 0.7158, floated by higher stock markets in Europe and an above-forecast composite PMI reading out of Australia. Global asset markets are likely to remain skittish, notwithstanding the rally today, with investors pondering the uncertainties presented by the surge in Covid cases in Europe and elsewhere, including now in any U.S. states and in Canada, and which are leading to ever more restrictive countermeasures. The ongoing delay in new U.S. fiscal stimulus and the event risk posed by the upcoming U.S. elections are also in the mix. Regarding the elections, polls point to a Biden presidency, but it is less clear if his Democratic party can take control of the Senate. If not, then Congress will remain split at least until the mid-term elections in two years, which will limit the scope for policy changes and crimp Democrat ambitions for expansive fiscal policy.

    [EUR, USD]
    EUR-USD has rebounded quite strongly back above 1.1850 from a three-day low at 1.1787. Once again, the directional shift has been driven by the dollar, which came under pressure during the European morning concurrently with a rally in stock markets, which have pared some of the declines seen over the last couple of weeks. Preliminary October PMI data in the services and composite readings out of the Eurozone undershot the median forecast of economists, but didn't impact the euro. The euro is up by over 1% on the dollar over the last week. Real interest rate and real yield differentials are mildly bullish for EUR-USD, while this week's successful first joint EU offering of social bonds, which will finance a jobs program, has both attracted foreign capital and shored up the reputation of the euro. Data this week also showed a rise in the Eurozone's current account surplus. Markets are also discounting a limited free trade deal between the EU and UK, which has been another positive for the common currency, in addition to the pound. This backdrop should curtail downside potential of EUR-USD. However, downside possibilities could become more pronounced if risk aversion in global markets were to intensify to the extent that capital is shifted to the haven offered by the liquid U.S. Treasury market. Global asset markets remain skittish, notwithstanding the rally today, with investors pondering the uncertainties presented by the surge in Covid cases in Europe and elsewhere, including now in many U.S. states and in Canada, and which are leading to ever more restrictive countermeasures. The ongoing delay in new U.S. fiscal stimulus and the event risk posed by the upcoming U.S. elections, particularly the perceived risk of the result being contested, are other uncertainties.

    [USD, JPY]
    USD-JPY is modestly softer after yesterday's rally stalled at 104.93. At levels around 104.70, the pair remains down by 1% on the high seen on Wednesday. The sharp decline was largely driven by dollar weakness, though the U.S. currency has since found a footing. The yen is also firmer against other currencies today. EUR-JPY is down for a third straight day, printing a four-day low at 123.42. AUD-JPY dropped back quite sharply after printing a four-day high (which was seen after an above-forecast composite PMI reading out of Australia). Japanese inflation data showed the headline September CPI rate fall to 0.0% y/y from 0.2% y/y in the month prior. Core CPI lifted slightly, to -0.3% y/y from -0.4% in August. When adjusting for the deflationary impact that the government's travel discount program has been having, core CPI is 0.0% y/y. This compares to the 1.7% y/y in U.S. CPI, which means that, with interest rates at near zero in both countries (Japan's policy rate at -0.1% and the mid range of the U.S. Fed funds target at 0.125%), real interest rates are higher in Japan than they are in the U.S. -- a mild, all else equal, negative for the nominal USD-JPY rate. In other data, Japan preliminary October PMI came in near expectations at 46.7 after the 46.6 reading in September. This is the ninth consecutive month the index has been below 50.0, indicating contraction in the private sector of the economy, and lagging relative to most peer economies, which partly reflects the relatively aged demographic in Japan. Both Japan and China are heading towards resuming travel between the two nations, which reflects the relatively contained status of the Covid coronavirus in Asia. The biggest directional force on the Japanese currency will likely remain shifting risk premia 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, is recognized in the currency market and has established the yen as a low-beta haven currency.

    [GBP, USD]
    The pound is trading neutrally, rebounding from a two-day low at 1.3051 in the case against the dollar, while seeing limited and mixed changes versus other currencies. The UK currency remains comfortably up on week-ago and month-ago levels against the dollar and euro, and others. The currency market is anticipating a limited trade deal between the EU and UK. The UK and Japan also signed, today, the trade deal that was agreed in principle a month ago. The northern coastal EU nations have been demanding unchanged fishing access to British waters, and this has been the principal sticking point. EU negotiator Barnier was this week reported by the BBC to have been "frustrated" with leaders of coastal EU nations for not (yet) allowing him to proceed on tackling inevitable compromises on fishing rights. Perhaps he arrived in London yesterday with authorization to open up this front. For the coastal 8, it's a choice between no fishing rights in UK waters under a no deal scenario versus reduced quotas with an agreement. With a limited trade deal, and taking into consideration the UK's progress in signing continuity agreements with non-EU trading partners, the UK economy and the pound would look vulnerable over the medium term. Swapping unfettered access to the EU's single market and customs union in place of a narrow free trade deal will see trading friction and costs rise. Uncertainty about the UK's outlook will likely remain well into 2021, as the relationship between the UK and the EU will be an evolving one. This backdrop, along with the direction of travel in the Covid situation and associated restrictions, should be viewed as potential negatives for the pound, given the risk of lower foreign capital inflows, which are needed to offset structural outflows generated by the UK's large current account deficit. This said, it should also be acknowledged that the EU and UK might conceivably amaze everyone with a much more comprehensive deal than is being expected. The Covid situation may be a motivation for this, and it should be remembered that the two sides are starting from perfect equivalence, so a broad agreement is entirely possible. Even Brexit ideologues in the UK might be persuaded that maintaining close alignment with EU rules -- for now -- may be the more pragmatic way forward given the Covid stresses.

    [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 ebbed to the lower 1.3100s, tracking a gain in oil prices currently. The U.S. dollar concurrently came under pressure. USD-CAD has been trending lower since March, though there are derailing risks, including the U.S. election and the trend toward ever more draconian Covid-related measures as the northern hemisphere heads into winter, which is crimping global growth.

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