WEEKLY NOTION - XE Market Analysis: North America - Nov 19, 2020

Currencies have been seeing relatively narrow ranges in risk-cautious trading, though the Australian and New Zealand dollars have racked up a 0.5% loss apiece versus the U.S. dollar, which has been trading with a firming bias. This has been concomitant with a pull back in commodity and global stock markets, with investors unwilling to commit fresh risk-on positions at prevailing lofty values and with northern hemisphere nations facing a tough pre-vaccine winter with regard to Covid-19 (and not just in Europe and North America, with Japan reporting a record daily rise in new positive Covid test results). The pound posted two- and 10-day lows against the dollar and yen, respectively, as anxieties about Brexit took hold, specifically with Brussels letting it be known that it is drawing up emergency no-deal plans, though the currency subsequently lifted. News that EU chief negotiator Barnier has cancelled briefings to EU states planned for next Tuesday evening and Wednesday morning was interpreted by pundits as being a good sign that a deal might be in the works. Cable lifted back to the mid 1.3200s after posting a two-day low at 1.3205, while EUR-GBP dropped back to levels around 0.8930 after earlier posting a high at 0.8964. We expect that win-win will prevail rather than lose-lose, and that an accord will be reached.

[EUR, USD]
EUR-USD ebbed to a three-day low at 1.1817, and EUR-JPY posted a 10-day low, with the common currency being affected by the lack of a breakthrough in future relationship negotiations between the EU and UK, with time now fast running out if there is to be sufficient time for the ratification process ahead of the UK's exit from the single market and customs union on January 1. The euro still managed to lift against the pound, with the latter underperforming given the asymmetrical impact that a no deal scenario would have on the UK economy relative to the eurozone economy. As for EUR-USD, the pair has once again turned lower after approaching the 1.1900 level. The pair has consistently failed to sustain gains above this level for almost four months now, reflecting a near to equilibrium stasis. Interest rates are near zero in both the U.S. and eurozone, and both the Fed and ECB are pursuing aggressive monetary easing policies, though a higher inflation rate in the U.S. means that the real interest rate in the U.S. is lower than in the eurozone. The U.S. is beating the eurozone on growth, but the eurozone is running a trade surplus relatively the the trade deficit in the U.S. The U.S. depends on capital inflow to fund its current account deficit, while the eurozone runs a strong balance of payments position. Overall, a picture of countervailing forces among these key metrics of exchange rate determination. We still retain a bearish long-term view on the dollar, which hinges on risk appetite holding up in global markets. The dollar's real effective exchange rate (as calculated by the BIS) remains at historically rich levels, and we expect broad declines in the U.S. currency over the longer term as investors seek higher yield value and growth opportunities around the world. The Fed's inflation-tolerant lower-for-longer policy rubric, and negative real interest rates in the U.S., are also considerations.

[USD, JPY]
USD-JPY has ebbed to a fresh one-week low at 104.24, which is now over a 50% retrace of the strong gains seen last Monday during the initial height of the so-called 'Covid vaccine' global equity market rally. The yen has been steady-to-firmer against other currencies, which in turn reflects a correction in the risk-on positioning theme of yesterday. Most stock markets have come off the boil, although the futures in the stay-at-home replete NASDAQ index have rallied by nearly 0.5%. Japan's Nikkei has recently been an investor favourite in the 'great rotation' into cyclical stocks, with well managed, large cap and export oriented companies in demand. Dividend yields in Japan are about 2.8%, better than to 2.2% return offered by U.S. companies, according to analysts at Schroders, and are near to the 3.0% dividend return found in many emerging markets. While foreign investor demand for Japanese shares is a capital inflow to Japan, these investors may be hedging out the currency exposure given the yen's proclivity for counter-cyclical trending. GDP data out of Japan and industrial production figures out of China yesterday reaffirmed a picture of stronger economic conditions compared to recently prevailing expectations. The mix of low interest rates (which enhances the value of corporate earnings), massive monetary and fiscal stimulus, along with spare capacity (which lowers costs), is a potently bullish tonic for equity markets. This looks like a recipe for a bubble, but there may be considerably more upside to be see yet.

[GBP, USD]
The pound is modestly firmer, with Cable posting a one-week high at 1.3295 and drawing in on the 10-week high seen last Wednesday is at 1.3310. EUR-GBP edged out a six-day low at 0.8939. The pound also posted a six-day high versus the Australian dollar. Sterling still remains lower against most of the other main currencies from week-ago levels, and is firmer from month-ago levels. On the year to date, the UK currency continues to register as the weakest of the main currencies due to UK having witnessed the biggest peak-to-trough GDP drop this year out of the G20 economies, alongside Brexit related uncertainties. The Brexit endgame drama is now reaching a climax. There is a lot of noise coming from officials and politicians, yet little response in the pound, with participants uncommitted, waiting on concrete developments. Neither the EU or UK has blinked yet in trade talks. The UK's trade negotiator Frost said that a a deal could be reached by next Tuesday, while an EU diplomat cited in the Sun tabloid said chiefs are working to avoid and "accidental no deal." Reuters reported that EU states will be updated on progress on Friday morning. Tensions are running high, as was always going to be the case at this critical juncture. Media sources are highlighting that France of Spain let it be known (again) that they could veto a deal agreed between Brussels and London, which yesterday elicited a terse reply from a spokesperson for PM Johnson asserting that the UK would "thrive" without a deal -- all very much par for the course in EU versus UK banter. We expect that win-win will prevail rather than lose-lose, and that an accord will be reached, and one potentially broader than is currently being anticipated in markets (Johnson has the pragmatic option of leaving the single market in close alignment with EU rules while pledging to Brexit ideologues in his party that the UK will diverge from EU rules over time). This would spark a rally in the pound should it materialise.

[USD, CHF]
EUR-CHF rallied from sub-1.0700 levels to levels above 1.0800. Coursing risk-on positioning weighed on the Swiss franc with investors factoring in a sea change in optimism about a vaccine solution to Covid-19. 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 lifted back above 1.3100 after yesterday posting an eight-day low at 1.3032. Oil prices came off the boil as investor sentiment turned more cautious after recent strong gains in cyclical assets. We still remain bearish of USD-CAD in the bigger picture. The OPEC+ group is considering extending the prevailing level of output quotas for three months (out to next March), and a six-month extension is also a possibility, aiming to support oil prices over a sustained period of relatively low demand as a consequence of Covid-19 related restrictions around the world. The group estimates that a six-month extension would swing the oil market back into deficit (i.e. a supply deficit) in 2021. Add in the increased optimism for a vaccine-assisted route out of the prevailing Covid situation, this sets oil up for a sustained rally in oil. USD-CAD has been trending lower since March, and we anticipate there is more to come. The current trend low is at 1.2928, which was seen last week, and which was the lowest level the pair has seen since October 2018.