XE Market Analysis: Europe - Mar 16, 2021

Currencies have been trading with stability amid a benign backdrop of buoyant stock markets and softer yields as markets anticipate dovish guidance from the Fed and tomorrow's conclusion of the FOMC meeting, which begins later today. This is despite the $1.9 tln fiscal stimulus, which is being implemented on top of a better than anticipated economic rebound, though the Fed, looking beyond the upcoming burst of inflation caused by base effects on the year-on-year price comparison, will point to spare capacity in the labour market. One side-theme of note today has been pound weakness, with Cable pushing nearly 0.5% lower in pegging a one-week low at 1.3822 and EUR-GBP rising by a similar magnitude in posting an eight-day high at 0.8625. This came after BoE Governor Bailey said that inflation will remain below the 2% target threshold even after the expected jump due to year-on-year base effects and economic reopening. Bailey also affirmed that the central bank will continue with its QE program for the remainder of 2021. The 10-year gilt yield nudged under 0.80% in the wake of his remarks. Yesterday Bailey downplayed recent yield gains, remarking that they have been in accordance will a brightening economic outlook. Elsewhere, both EUR-USD and USD-JPY traded in narrow ranges, respectively above and below their recent lows and highs. AUD-USD drifted lower, though remained above Monday's low. USD-CAD lifted, but remained below yesterday's rebound high at 1.2513, which was seen after a 37-month low was clocked at 1.2446. The pair had been weighed on by Friday's strong employment report out of Canada, which sparked a narrowing in the U.S. over Canadian yield differential. A drop in oil prices subsequently offset this by weakening the loonie. In news today, BoJ Governor Kuroda said there was no need to change the yield curve control framework, and that it was vital to keep the yield curve low and stable. The Japanese central bank reviews policy later this week, announcing on Friday. U.S. President Biden said that he would not improve relations with China until Beijing ceases its economic coercion of Australia. A renewed rise in Covid cases is being seen in much of Europe, outside the UK, which is being driven, somewhat ironically, by the highly transmissible UK variant. GS is forecasting 10-year T-note yield to rise to 2%, remarking that this will be digestible for equity markets, which is a view we concur with.

[EUR, USD]
We remain bearish of EUR-USD. The ECB last week surprised markets by announcing a ramp up in its asset purchase program in an effort to dampen rising yields. Markets are also focusing on growth and yield differentials, and the U.S. economy is widely seen outpacing the Eurozone and other peers this year, thanks in large part to the massive upcoming fiscal spending spree. Eurozone interest rates are near the most negative in the world (barring Swiss rates), and there is little expectation for the ECB to tighten policy, contrasting to the debate about the Fed, and the possibility it may be forced to tighten sooner than expected.

[USD, JPY]
The yen has retained a weakening bias amid a backdrop of ascending global equity markets. USD-JPY yesterday printed a fresh nine-month high at 109.36. Yen crosses remained underpinned, with EUR-JPY and CAD-JPY, for instance, posting fresh major trend highs on Monday. The rootedness of JGB yields has lately been seeing differentials has tipped marked out of the yen's favour. The yen is registering as the weakest of the main currencies on the year so far. The BoJ announces on monetary policy this Friday following a two-day meeting of policymakers. The central bank is under pressure to expand the target rage in its yield curve control program, and may announce a phasing out of numerical targetting. BoJ Governor Kuroda said today there was no need to change the yield curve control framework, and that it was vital to keep the yield curve low and stable.

[GBP, USD]
Pound weakness pushed Cable nearly 0.5% lower in pegging a one-week low at 1.3822 and lifted EUR-GBP by a similar magnitude, with the cross posting an eight-day high at 0.8625. This came after BoE Governor Bailey said that inflation will remain below the 2% target threshold even after the expected jump due to year-on-year base effects and economic reopening. Bailey also affirmed that the central bank will continue with its QE program for the remainder of 2021. The 10-year gilt yield nudged under 0.80% in the wake of his remarks. Yesterday Bailey downplayed recent yield gains, remarking that they have been in accordance will a brightening economic outlook.

[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 lifted, but remained below yesterday's rebound high at 1.2513, which was seen after a 37-month low was clocked at 1.2446. The pair had been weighed on by Friday's strong employment report out of Canada, which sparked a narrowing in the U.S. over Canadian yield differential. A drop in oil prices subsequently offset this by weakening the loonie. Oil prices have been trending strongly higher since the sub-zero nadir last April, particularly since last November, when the reflation trade, the vaccine-assisted return to societal and economic normalcy, started to be priced in. Crude markets are now amid the fifth consecutive month of appreciation, with the upward trend having accelerated in February amid a fad for $100 price targets. However, the upside momentum has been weakening. Prides have become quite lofty, having long since been re-established to pre-pandemic level norms, while global demand has continued to lag behind pre-Covid levels. The OPEC+ group have maintained tight quotas through to April, though the discipline is looking increasingly likely to falter, with Russia in particular chomping at the bit to increase supply. U.S. shale production will also continue to ramp higher, despite some hindrances imposed by the Biden administration. The plateauing trajectory of oil prices, may remove a leg of support for the Canadian currency in the weeks ahead. Yield differentials are likely to remain a dominant directional determinant of USD-CAD.