XE Market Analysis: North America - Jan 07, 2021

The dollar has rebounded out of the major-trend lows that were seen yesterday. The DXY dollar index posted a three-day high at 89.95, up from yesterday's 33-month low at 89.21, while EUR-USD dropped over 0.5% to the mid 1.2200s while USD-JPY rallied to a nine-day high at 103.71. Markets have been discounting the upcoming Biden administration with Democrat control of both the House and Senate. The protests of Trump supporters at Capitol Hill also caused some concern. Together, they have prompted a modest rebound in the dollar. The Democrat sweep will see a rising budget deficit and an increased prospect for stronger growth. This can be chalked up as a dollar positive influence, especially amid a favourable widening in U.S. Treasury yields relative to peers, though inflation is also set to rise further in the U.S. than in a split House scenario, which, given the Fed's inflation-tolerant lower-for-longer monetary policy strategy, will impart a downside bias on real U.S. interest rates. We still retain an overall bearish view of the dollar, anticipating declines in U.S. real interest rates and real yields relatively to peers, alongside an investor rush to better-valued assets outside the U.S.

[EUR, USD]
EUR-USD has corrected to the mid 1.2200s after capping out at a 33-month high yesterday at 1.2350. Markets are digesting the upcoming Biden administration with Democrat control of both the House and Senate. The protests of Trump supports at Capitol Hill also caused some concern. Together, they have prompted a modest rebound in the dollar. The Democrat sweep will see a rising budget deficit and an increased prospect for stronger growth. This can be chalked up as a dollar positive influence, though inflation is also set to rise further in the U.S. than in a split House scenario, which, given the Fed's inflation-tolerant lower-for-longer monetary policy strategy, will impart a downside bias on real U.S. interest rates, which is an negative force on the nominal value of the dollar. Already the U.S. has discernibly lower real interest rates versus Japan and the Eurozone, among other peers. With regard to the euro, the common currency has recently been attracting demand as a consequence of the EU's historic EUR 1.8 tln budget-and-recovery package. Since late October, the EU's has issued several social bonds under the EU SURE instrument (Support to mitigate Unemployment Risks in an Emergency), all of which were massively over-subscribed, reflecting demand from long-term investors like life insurance companies, who have a prevailing need for long-term triple-A bonds to invest in to match their liabilities. While not the first time the European Commission has borrowed in capital markets on its own account, it marks a significant upscaling. In 2021, the European Commission will launch borrowing under the €750 bln NextGenerationEU instrument, which is a pandemic recovery investment finding vehicle aimed at investing in green and digital technologies. Overall, we remain bullish on EUR-USD.

[USD, JPY]
USD-JPY has rallied to a nine-day high at 103.71, extending the rebound from the 10-month low that was seen yesterday at 102.58. A spike in U.S. Treasury of JGB yield differentials as markets discount the Democrats clean sweep has been in the market mindset, with the dollar also rebounding across the board. Prospects for greater budget deficit fuelled growth also bodes well for the U.S. growth differential versus Japan and other economies, although the combo of higher inflation and the Fed's lower-for-longer rubric on interest rates is likely to see real interest rates decline deeper into negative territory. In Japan, the economy is heading back into contraction, as confirmed by the December PMI surveys, with many parts of the country locking down in the face of rising positive Covid test results.

[GBP, USD]
The pound has been moderately underperforming during the first week of the UK having left the EU's common market and customs union. The underperformance is more attributable to UK nations, as of yesterday, having gone into a 'tier 5' lockdown, the most restrictive level since the full lockdown of spring last year, although manufacturing, auto repair businesses, DIY and garden stores, remain open, along with food sellers. High street retail, aviation and other public transport, along with the hospitality sector, are bearing the brunt of the lockdown, as in other nations, although the percentage impact on GDP from these sectors being closed is bigger in the UK than most peers. The UK economy underperformed its G20 peers during lockdowns last year, so the thinking, as being expressed in market narratives, is that the UK will be apt to underperform again (although the way the UK compiles GDP data relative to other G20 nations may have exacerbated the picture). Then there is the fact that UK's terms of trade with the EU has eroded in the post-Brexit world, despite the deal, with the key financial services sector left in a strategically more precarious position than before, with participation in EU markets dependant on the latter's equivalency rules, although London's competitive advantage in this area should protect the sector over the near- to-medium term. This said, there is potential for pent up business investment, with Brexit uncertainty having finally cleared, while the UK is ahead of the pack in rolling out a Covid vaccination program. Weakness in the pound may prevail for a time, but with the government aiming to have nearly 25% of the UK population vaccinated by mid February, including all of the most at-risk groups -- the pound looks a much better bet in the bigger view.

[USD, CHF]
The recent weakening in the Swiss fran 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 has rallied above 1.2700, extending a rebound from yesterday's 33-month low at 1.2628. Oil prices gained for a third consecutive day, which saw front-month WTI futures print a new 11-month high at $51.28, the culmination of a 5.6% rally on the week so far. Crude prices have been underpinned by weekly U.S. inventory data yesterday showing a drop in stockpiles, and by Saudi Arabia announcing that it will be unilaterally dropping its output quota for two months. Prospects for a big spending Biden administration in the U.S. have also been in the mix. Earlier in the week, the OPEC+ group had also announced that prevailing production quotas, which are been decided on a monthly basis now, would be maintained in February, although Saudi's subsequent unilateral action means that supply will in fact drop. Altogether, these developments have turned around what had been looking to be a bearish phase for oil prices, given the demand-sapping impact of Covid lockdown measures across Europe and other major economic areas across the northern hemisphere.