XE Market Analysis: North America - Dec 08, 2020

The pound has traded softer on Brexit anxiety, but not dramatically so and the currency has remained above lows seen yesterday against the dollar, euro and other currencies. Dollar pairings and cross rates have outside the involvement of sterling, remained directionally unvaried.

Price action in global asset markets continued to reveal a level of risk wariness among investors. The Nasdaq 100 still closed at yet another record high yesterday, while the DJIA and S&P 500 posted moderate declines. The Nasdaq has become unrepresentative of broader stock markets, being dominated by FAANG and other cash-rich stay-at-home enabling companies, and where value is based on expected future earnings potential. Some have recently been likening the Nasdaq index to a safe haven asset, although at the same time being both a bear and bull market play.

Most equity markets across the Asia-Pacific region today have declined, by varying degrees, though most by a relatively moderate extent. European markets are down, as are DJIA and S&P 500 futures. Market narratives are ascribing the risk-wary tone as being a consequence of rising positive Covid tests across northern hemisphere nations, and the associated doubling down of containment measures, along with the logistical challenges of the vaccine program. The time of the year, December, along with the recent depletion in global fund manager cash (as highlighted by the latest BoA fund manager survey), are other factors.

SeintimenTraders SMI -- smart money index -- which attempts to gauge the attitudes of hedge funds and other fund managers, is nearing its lowest levels of the year. As for the dollar, the risk-cautious backdrop has had the effect of taking the steam out of the currency's downtrend. For those bullish on global equities and bearish on the dollar, a level of tactical hedging might be warranted to cover the year-end period. As for the pound, the Brexit excruciating endgame is unfolding. UK PM Johnson offered a concession to the EU, to remove the offending elements of the controversial internal markets bill (likely his intention all along). Johnson will be in Brussels "in the coming days" for face-to-face meetings. We continue to expect a deal, though the risks of no-deal seem palpable, with France maintaining a more hawkish stance on fishing than many anticipated. There have been reports that fishing is a sideshow, being used by the EU to pressure the UK. The real issue is governance and an appeal process, where the UK sees EU demands as undermining its sovereignty.

[EUR, USD]
EUR-USD has settled in the lower 1.2100s amid a pause in the bull trend that left a 32-month peak at 1.2177 last Friday. The risk-cautious backdrop in global markets has seen the dollar's downtrend lose steam, which might become an enduring theme for the remainder of December. We remain bullish on EUR-USD into 2021, on the proviso that global asset markets remain in a bull trend, on stimulus, on a successful vaccine-assisted return toward societal and economic normalcy, on a release of pent-up consumer demand in major economies, on low-interest rates, and so forth.

In this scenario, the asymmetry between richly valued U.S. stock markets versus much less richly valued markets in Europe and across the emerging world will generate capital outflows out of the dollar. The Fed's inflation tolerant policy rubric, which should keep U.S. real interest rates on a loosening path, is also also a dollar negative.

[USD, JPY]
USD-JPY has remained directionally limited, holding near the 104.00 level. Yen crosses have lost upside traction, and many have dipped amid a risk-wary sentiment in global markets. Lofty valuations in asset markets, along with a winding down in commitment into year-end have whittled on the previously strongly bullish sentiment. Regarding USD-JPY specifically, both currencies are safe haven, counter-cyclical currencies, which limits the directional scope for the pairing, though the real interest rate differential between the U.S. and Japan is a mathematical negative for the nominal exchange rate.

Outside the case against the dollar, the yen is amid what we are tagging as a longer-term softening trend, especially against the cyclical currencies, including the dollar bloc, although this may not resume until the near year. The yen's broader performance should continue to derive from the level of risk appetite 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, has established the yen as a low-beta haven currency.

[GBP, USD]
Sterling has traded softer on Brexit anxiety, as negotiations go down to the absolute wire, but declines have been far from dramatic, with the currency remaining above lows seen yesterday against the dollar, euro and other currencies. UK PM Johnson offered a concession to the EU, to remove the offending elements of the controversial internal markets bill, which was likely his intention all along. Johnson will be in Brussels "in the coming days" for face-to-face meetings.

Both himself and a government spokesperson yesterday touted his call with EU's von der Leyen late yesterday as make or break. If not a 'make', it clearly wasn't a 'break'. France minister for foreign affairs Beaune said early that there is still room for a deal while mentioning the complexities involved. There is a sense that the negotiating teams have gone as far as they can, and it's now, finally, down to the heads of state to bring matters to a close. We continue to expect a deal, though the risks of no-deal seem palpable, with France maintaining a more hawkish stance on fishing than many anticipated.

There have been reports that fishing is a sideshow, however, being used by the EU to pressure the UK. State aid, and more particularly the issues of governance and an associated appeal process are the fundamental issues, with the UK seeing the EU's demands as undermining its sovereignty. There are strong of win-win incentives for both sides to reach an accord, even if only a narrowly based one. Johnson will need to have enough to sell it to the powerful Brexit ideologue faction in his party, as his position as the leader will weaken if not. As for the deadline, EU chief negotiator mooted yesterday that Wednesday (tomorrow) is the "hard" deadline. We shall see.

[USD, CHF]
EUR-CHF has settled around 1.0800 after failing to sustain recent gains above 1.0850. Recent risk-on positioning had been weighing on the Swiss franc with investors factoring in a sea change in optimism about a vaccine solution to the Covid-19 crisis. This will be pleasing to policymakers at the SNB, given their chronic disquietude about the franc's value.

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 found a footing and maybe in for a relatively sustained rebound after posting a 26-month low at 1.2770 on Monday. Oil prices have softened after reaching a nine-month peak on Friday, and there may be more to go in this theme. While the bigger picture prospects remain bullish for oil and oil-correlating currencies, such as the Canadian dollar, the nearer term looks more challenging.

Oil supply is on the up, with Libyan supply going back to pre-blockade levels, Norway has announced a rise in output from year-end, and the OPEC+ group having announced a 500k barrels per day increase from January. There are also signs that OPEC dissent is increasing, as highlighted by a Chatham House last week, with multiple participants in the output quotas unwilling to comply any longer.

There are also expectations that U.S. president-elect Biden will reduce will lift sanctions on Tehran, which would see Iranian output increase. All this comes amid increasing Covid-related restrictions across North America, and with Europe is maintaining restrictions.

While Covid vaccination programs have started in Russia and the UK, and in the U.S. as soon as next week, these won't have much impact in alleviating restrictions over the northern hemisphere winter. The scene looks to be set for a near-term correction in oil prices, which would see USD-CAD's directional bias shift from the downside to the upside for a period.