XE Market Analysis: Europe - Jan 04, 2021

The dollar has started the new year with a declining bias, which is of course where it left off last year. This comes against the backdrop of a coursing "everything rally", with the MSCI Asia-Pacific equity indexand S&P 500 futures hitting record highs. Base metals and oil prices also rallied, and the main crypto currencies hit fresh record levels. The dollar itself is correlating inversely with this theme, with U.S. assets at relatively rich valuations and with the Fed pursing an inflation-tolerant monetary policy strategy, keeping interest rates at near zero while continuing with asset purchases, which is maintaining lower real interest rate differential between the U.S. and many other economies. The DXY dollar index dropped nearly 0.5% in posting a low at 89.59, which is 7 pips shy of the 33-month low that was seen last week. EUR-USD lifted to a 1.12259 high, though remained shy of the pair's 33-month peak at 1.2311. USD-JPY eked out a 10-month low, at 102.85, while Cable traded above 1.3700 for the first time since May 2018, posting a high at 1.3703. AUD-USD lifted but remained short of the 33-month high that was seen last week at 0.7743. The Kiwi dollar also remained below the major trend highs that were seen last week. USD-CAD, meanwhile, posted a new 33-month low at 1.2684, weighed down by both softness in the U.S. dollar and a degree of outperformance in the Canadian dollar which, like other oil-correlating currencies, benefited from new highs in oil prices. Front-month WTI crude futures lifted over 2% to the highest levels seen since last February, posting a peak earlier at $49.70. Bitcoin and other crypto currencies are showing intraday declines after fresh record highs were reached. Ahead, focus will remain on the global Covid vaccine rollout, and, in the U.S., the runoff elections in the state of Georgia, the outcome of which will determine control of the Senate, and in turn set the legislative agenda for Congress. The details of the EU-UK future relationship deal are still be worked through, too. Overall, heading into 2021, we retain a bearish view on the dollar, and are bullish on the dollar block and emerging market currencies. On the pound, we are cautiously bullish.

[EUR, USD]
We remain bullish on EUR-USD into 2021, on the proviso that global asset markets remain in a bull trend, which looks likely amid the mix of fiscal stimulus, prospects for a vaccine-assisted return toward societal and economic normalcy, an anticipated release of pent-up consumer demand in major economies, low interest rates, and so forth. In this scenario, the asymmetry between richly valued U.S. stock markets versus comparatively lower priced markets in Europe and across the emerging world would propel net dollar-weakening capital flows. The Fed's inflation tolerant policy rubric, which should keep U.S. real interest rates on a loosening path, is also a key dollar-negative consideration. The two Georgia run-off elections tomorrow (January 5th) presents some market risk, as the outcome will decide whether the Republicans or Democrats will control the Senate. Democrats need to win both to level the Senate at 50-50, with control swinging to the Democrats due to the tiebreaker vote of Vice President-elect Kamala Harris. For currency markets, a Democratic presidency and a split House -- the most likely scenario -- is seen as bearish for the dollar, while a Democratic presidency and House is seen as dollar bullish, or at least less dollar bearish (due to greater demand-side stimulus, driven by healthcare and infrastructure spending).

[USD, JPY]
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]
Cable traded above 1.3700 for the first time since May 2018, posting a high at 1.3703. The high reflects dollar weakness, with the pound trading mixed overall -- holding steady against the euro while losing ground to the dollar bloc. We are moderately bullish on the pound from here. Brexit uncertainty has finally come to an end, which will unleash a process of business adaptation and pent-up investment. Aside from the deal with the EU, the UK has now signed up to 62 trading agreements around the world. The latest addition was a deal with Turkey, which was finalised last week. Deals with Albania, Cameroon and Ghana are also in the pipeline, and, further out, a deal with the U.S. is to be expected. Most of the deals so far are continuity agreements, which replicate terms that existed under EU agreements, and will be open to expansion over time. The UK currency will potentially be an outperformer in the 2021 recovery trade, which hinges on successful vaccination programs bringing an end to the lockdown era, as the UK economy underperformed G20 peers during the 2020 lockdowns and restrictions (although this picture was at least partly exacerbated by the way the UK compiles GDP data). UK equities are cheap compared with global peers, especially U.S. stocks.

[USD, CHF]
EUR-CHF has lifted back above 1.0800, influenced by gains in EUR-USD. 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. The recent weakening of the currency will have been 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 repeated at its latest quarterly monetary policy review that the franc remains "highly valued" and said it is ready to intervene directly in the foreign exchange market.

[USD, CAD]
USD-CAD posted a new 33-month low at 1.2684, weighed down by both softness in the U.S. dollar and a degree of outperformance in the Canadian dollar which, like other oil-correlating currencies, benefited from new highs in oil prices. Front-month WTI crude futures lifted over 2% to the highest levels seen since last February, posting a peak earlier at $49.70. While crude prices are being caught up in the "everything rally" as investors look to a post-lockdown rebound in world economies, there are reasons for caution with regard to crude. Oil supply is increasing, Covid lockdowns and restrictions are still ratcheting across Europe and other areas of the northern hemisphere, and the price of crude is already back within pre-pandemic ranges. This could set crude prices up for a sharp correction at some point, perhaps on the trigger of any weekly inventory showing a bigger than expected build in oil stockpiles.