XE Market Analysis: Europe - Jan 08, 2021

The dollar's correlative pattern with stock markets has inverted, with the currency now rising in step with rallying global stock markets. The catalyst for the change was the Democrat wins in the Georgia runoff elections, which heralds the prospect of much greater deficit spending and warranting higher growth expectations for the U.S. economy. U.S. Treasury yields have also spiked more than peers, and much more so in the case against JCG and Bunds, which appears to have offset implications for lower real interest rates and real yields from the anticipated higher inflation curve. The dollar's new correlative pattern may not persist, as the global reflation trade may still ultimately suck more capital out of richly valued U.S. assets and into more cheaply priced assets around the globe. In markets today, the MSCI Asia-Pacific equity index posted a fresh record higher, and Japan's Nikkei a 30-year peak. This followed the main indices on Wall Street posting fresh record highs yesterday, and the Stoxx 600 European index hitting new 11-month highs. Front-month WTI oil prices hit a new 11-month high earlier, at $51.33. In the forex realm, the DXY dollar index posted a 10-day high at 90.03, while EUR-USD etched out a four-day low at 1.2234 and USD-JPY lifted to a 24-day peak at 104.00. Cable settled in the mid 1.3500s, above the 10-day low the pair saw yesterday at 1.3532. The dollar bloc currencies remained in relatively narrow ranges in a consolidating pattern under the 33-month highs that were seen against the U.S. dollar earlier in the week. Bitcoin settled after yesterday storming to yet another record high, this time above 39,000. The crypto currency is up 364% since last September, which has come amid a growing sense that the new asset class is becoming of age, being more accepted by institutional investors and competing with gold as an inflation hedge. One thing to be aware of is that UK scientists have expressed concern that the current vaccines may not be effective in protecting against the new 'South Africa' variant of Covid. Incoming data on this will throw better light on this over the coming weeks. Any verifiable signs that vaccinations prove ineffective against new strains would be majorly dispiriting for investors given their prevailing bets for a stimulus-fuelled return toward economic normalcy later in 2021 are largely hinged on the implementation of successful vaccination programs around the world.

[EUR, USD]
EUR-USD etched out a four-day low at 1.2234. Markets are digesting the upcoming Biden administration with Democrat control of both the House and Senate has prompted a 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. Much of Europe is in the tightest level of lockdowns since the 'mother lockdown' in spring last year, which threatens to put the region back in recession. Data out of Europe continue to show the manufacturing sector holding up, while the service sector takes a beating, bearing the brunt of Covid restrictions. The U.S. is of course also being negatively affected by Covid restrictions, though there is considerable variation in levels of response state by state. Overall, this backdrop, along with dollar-favourable shift in U.S. Treasury versus Bund yield differentials, has taken the wind out of the EUR-USD's uptrend. The pair had earlier in the week clocked a 33-month high at 1.2350. The U.S. December nonfarm payroll report is up today. We're forecasting a 100k increase but see the chance for a decline as suggested by the 123k drop in the headline ADP report. We see the unemployment rate ticking up to 6.8% from 6.7%. Earnings should edge up 0.2%.

[USD, JPY]
USD-JPY lifted to a 24-day peak at 104.00, extending the rebound from the 10-month low that was seen on Wednesday 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 recoup the moderate underperformance that was seen earlier in the week, and looks set to close out the first week of the UK's Brexited life on a neutral footing. UK nations have 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 there is some thinking in market narratives 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). The UK's terms of trade with the EU has eroded in the Brexied 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. There is also 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. One thing to note is that UK scientists have expressed concern that the current vaccines may not be effective in protecting against the new 'South Africa' variant of Covid. Incoming data on this will throw better light on this over the coming weeks.

[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 continued to consolidate near the 1.2700 level, above the 33-month low that was seen earlier in the week at 1.2628. A rebound in the U.S. dollar has offset continued strength in the Canadian currency, which has been more apparent against other currencies. The Canadian dollar has today, for instance, posted one-week and one-month highs against the euro and yen, respectively. This has come concomitantly with front-month WTI oil prices hitting a new 11-month high at $51.33, which is the culmination of a near 6% rally on the week so far. Crude prices have been underpinned by weekly U.S. inventory data this week 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.