XE Market Analysis: Europe - Jan 25, 2021

The dollar is modestly lower amid a risk-on backdrop in asset markets. Data showing China had received $163 bln of foreign direct investment inflows, more than the U.S. received, boosted sentiment across Asian equity bourses. The MSCI Asia-Pacific came within a whisker of a new record high. U.S. stock indices futures also rallied. Global stimulus and a visible route out of the Covid-induced lockdown crisis remains a relevant investment thesis, although weakened in light of the ever-tightening response to Covid. Hong Kong, for instance, locked down an area of Kowloon for the first time since the pandemic started. There is also considerable media focus on variant strains of the SARS-Cov2, along with vaccine supply issues in Europe. This suggests the prevailing bullish bias in asset markets may not sustain, which may in turn leave the dollar and currencies in a directional limbo for a period. We still anticipate a fully revival in the reflation trade, which is hinged on vaccination programs proving to be successful. Seasonal drivers of the coronavirus should also start kicking in and markedly reduce impact within a few months across the northern hemisphere, which should in itself allow for some alleviation in restrictions. The DXY dollar index has ebbed to a 90.08 low. Both EUR-USD and USD-JPY have seen less than respective 25-pip ranges. The dollar bloc currencies gained moderately, though remained well within ranges seen last week.

[EUR, USD]
EUR-USD has settled to a narrow range today after rising late last week, aided by messaging form the ECB. The central bank's post-policy meeting statement being a tad more hawkish than most had been anticipating in that it spelled out that the PEPP volumes doesn't need to be used in full, with President Lagarde also highlighting that while virus restrictions have tightened since the last meeting, there were also major positive developments that should support the medium term recovery, including the Brexit deal. The ECB policy position contrasts that of the Fed, which is committing to a relatively inflation tolerate low interest rate policy, which is something that has been in the mindset of markets. Overall, we remain bullish on EUR-USD. The latest update of the 'Big Mac index' of the Economist magazine, which is a PPP measure of relative currency valuations, found the euro to be 9% undervalued relative to the dollar.

[USD, JPY]
USD-JPY has settled to directionless trading. The BoJ this week left the main monetary policy settings unchanged, as had been widely expected. The deadlines for some funding programs were extended, with the central bank taking a grimmer view on the current state of the economy, although it also upped its growth forecast for the expected recovery in the next fiscal year. The yen's 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]
The pound is showing moderate net gains versus the dollar, euro and yen on the year-to-date -- that is to saw since the UK finally Brexited -- and is holding its own against the dollar bloc currencies. We remain bullish on the pound. This month's update of the Economist magazine's Big Mac index, a measure of 56 currency valuations according to the theory of purchasing power parity, showed the the pound to be 22% undervalued against the dollar. The UK is among the leaders of the pack in the rollout out of Covid vaccinations, and is on track to have nearly 25% of the population vaccinated including nearly all of the at-risk groups as soon as mid February. At this point, the UK government will start reversing restrictions, although most likely this will be in a cautious stage-by-stage process over several months.

[USD, CHF]
Policymakers at the SNB retain a 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 corrected some of the gains seen on Friday in dipping to the upper 1.2600s. The pair remains above the 33-month low that was seen last Thursday at 1.2589. Oil prices are slightly firmer today, but have overall come off the boil after nearing 11-month highs earlier last week, with data showing an unexpected build in U.S. weekly crude inventories curtailing the market's upside. The global reflation trade is much diminished compared to what it was back in November and December due to concerns about the extensiveness of prevailing Covid restrictions in the northern hemisphere, vaccine supply issues and worries about new variant strains of the SARS-Cov2 coronavirus. We had been noting reasons for caution with regard to oil's upside potential, given demand-sapping Covid restrictions across the northern hemisphere, and with tanker-tracking data showing compliance among OPEC+ producers to maintain output quotas falling to 75% in December.