XE Market Analysis: Europe - Nov 20, 2020

Currencies have largely remained within recent range bounds as a risk-cautious sentiment continues in global asset markets. Asian stock markets lifted after starting out weak, with the main indices across the region showing a mix of modest losses and modest gains. S&P 500 E-mini futures dropped 0.4% after the cash version of the index finished on Wall Street yesterday with a fraction 0.1% loss. Base metal prices remain perky, with copper lifting to near recent trend highs while aluminium prices posting a new two-year high. Bitcoin surged to a fresh three-year high. Markets were somewhat flustered after U.S. Treasury Secretary Mnuchin announced yesterday that key pandemic lending programs at the Fed (the near half a trillion dollars under the CARES Act) would expire at year end, with Congress, instead, to reallocate the funds. The timing is inauspicious, with California and other states announcing increasing Covid restrictions. This would assuredly be reversed by the incoming Biden administration, while there was news that Democrats and Republicans agreed to restart discussions about on a new fiscal package. In Asia, the PBoC kept the Loan Prime Rate unchanged for a seventh straight month while draining a net CNY80 bln via monetary policy tools, suggesting that the bank is tapering its emergency support programs. Japan core inflation fell to -0.7% y/y, which will cause an unwanted tightening in real interest rates in Japan. Among currencies, the DXY dollar index matched Wednesday's 11-day low at 92.21 while EUR-USD lifted to a two-day high at 1.1891. USD-JPY plied a sub-20 pip range in the upper 103.00s, holding above the 11-day low that was seen earlier in the week at 103.64. Sterling traded modestly firmer against the dollar, euro and yen, among other currencies, though mostly held within recent ranges. Cable edged out a two-day high at 1.3288. The pair's two-and-a-half month high, clocked on Wednesday, is at 1.3314. Trade talks between the EU and UK are commencing via video conference after one of the EU's team tested positive for Covid. The latest in a series of deadlines that have so far come and gone, now appears to be mid next week. Canada looks set to become the latest partner to sign a continuity trade agreement with the UK.

[EUR, USD]
EUR-USD lifted to a two-day high at 1.1891. The pair has consistently failed to sustain gains above the 1.1900 level for almost four months now. There hasn't yet appeared to be sufficient disequilibrium to drive the pair higher. 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, however, 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. An ongoing rotation out of too expensive tech stocks would fit this theme. 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 plied a sub-20 pip range in the upper 103.00s, holding above the 11-day low that was seen earlier in the week at 103.64. Japan core inflation fell to -0.7% y/y, which will cause an unwanted tightening in real interest rates in Japan. This contrasts to the negative interest rate in the U.S., which a bearish USD-JPY factor, all else equal. Like many other winter-bound northern hemisphere nations, Covid cases are surging, which is causing tighter restrictions to be imposed on the economy.

[GBP, USD]
Sterling has traded modestly firmer against the dollar, euro and yen, among other currencies, though mostly held within recent ranges. Cable edged out a two-day high at 1.3288. The pair's two-and-a-half month high, clocked on Wednesday, is at 1.3314. Trade talks between the EU and UK are commencing via video conference after one of the EU's team tested positive for Covid. The latest in a series of deadlines that have so far come and gone, now appears to be mid next week. Canada looks set to become the latest partner to sign a continuity trade agreement with the UK. Fishing rights and level playing field rules remain the stumbling blocks between the EU and UK, and neither side is showing any sign of wanting to make any concessions. An EU source cited by the UK's Sun tabloid said that talks can only continue to mid next week before "time will get the better of us." Time really is running out now given the time needed for the ratification process before the UK's exit from the common market and customs union on January 1. It would be imprudent to rule out the risk of a no deal, but we still expect win-win will prevail rather than lose-lose, and that an accord will be reached. It should be factored that UK PM Johnson has a pragmatic option available: to leave the single market in close alignment with EU rules and then diverge from them in an evolving process -- to achieve a hard Brexit in the least damaging way, which would seem especially warranted given the Covid situation and the prospect of a Biden presidency. Johnson would have to sell this to Brexit ideologues, which won't be easy and not without political risk, but this may be better than the economic carnage a no deal scenario would cause.

[USD, CHF]
EUR-CHF has established a consolidation range around the 1.0800 level after recently rallying from sub-1.0700 levels. Recent 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 has remained heavy, declining towards 1.3050 and Wednesday's nine-day low at 1.3032. Oil prices have come off the boil though have remained buoyant, in the the lower $40s (WTI benchmark), despite Libya's production returning to pre-blockade levels. Investor sentiment has turned more cautious after recent strong gains in cyclical assets. We remain bearish of USD-CAD in the big 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, although the nearer term outlook is less certain. 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.