XE Market Analysis: North America - Dec 21, 2020

A sharp decline in the pound and a correction in the reflation trade, which has seen the dollar and yen rebound while cyclical currencies, including the dollar bloc, underperform, have characterized and unusually active Monday session, especially one that comes at the beginning of Christmas week. The pound has been negatively impacted by the EU and UK missing yet another deadline to reach a future relationship agreement. The EU Parliament last week demanded that a text of an agreement be made available by midnight yesterday to allow time for elected members to scrutinise it before voting to ratify it. This is just the latest in a series of deadlines that have come and gone. The legal deadline is midnight of next Friday. Neither side has walked, however, and negotiations will continue this week. We still expect a deal, though the risk of a no-deal scenario is palpable. A new strain of the Covid coronavirus, meanwhile, has been detected in the UK, which is reportedly more transmissible -- though not, according to scientists, more virulent nor likely to render vaccinations obsolete -- which has sparked a bout of hedging in reflation positioning. The news prompted EU nations to ban UK travel and halt Channel freight. While positive tests results have spiked in the UK, it's worth noting amid the panic that UK hospital admissions are as yet about normal for the time of year, with the number of Covid patients receiving treatment in ICU are still a fraction of the peak seen during April. There has been been many thousands of mutated variants of Covid detected during 2020, with some virologists arguing that this new variant is likely to be less virulent (as less infected people are made ill by it and therefore remain in circulation among the population). However, these considerations are moot points given the political necessity for an extreme response. Parts of the UK, including London are now in the top-level lockdown, which will have an economic impact similar to that see in the first lockdown. The pound is likely to remain under heavy pressure.

[EUR, USD]
EUR-USD has corrected lower after last week posting a fresh major-trend highs last week. 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 on January 5th presents some market risk, as the outcome will decide whether the Republicans of 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]
The pound has come under heavy pressure, falling by nearly 2% against the dollar, impacted by the EU and UK missing yet another deadline to reach a future relationship agreement and by news of a new, more transmissible strain of the Covid coronavirus in the UK, which has led to severe lockdowns in London and other parts of the country. The EU Parliament last week demanded that a text of an agreement be made available by midnight yesterday to allow time for elected members to scrutinise it before voting to ratify it. This deadline has now come and come. Neither side has walked, however, and negotiations will continue this week. We still expect a deal, though the risk of a no-deal scenario is palpable. The new strain of the Covid coronavirus, meanwhile, is reportedly more transmissible -- though not, according to scientists, more virulent nor likely to render vaccinations obsolete. The news prompted EU nations to ban UK travel and halt Channel freight. While positive tests results have spiked in the UK, it's worth noting amid the panic that UK hospital admissions are about normal for the time of year, with the number of Covid patients receiving treatment in ICU are still a fraction of the peak seen during April. There has been been many thousands of mutated variants of Covid detected during 2020, with some virologists arguing that this new variant is likely to be less virulent (as less infected people are made ill by it and therefore remain in circulation among the population). However, these considerations are moot points given the political necessity for an extreme response. Parts of the UK, including London are now in the top-level lockdown, which will have an economic impact similar to that see in the first lockdown. The pound is likely to remain under heavy pressure.

[USD, CHF]
EUR-CHF has lifted back above 1.0800, influenced by gains in EUR-USD and a broader advance in the euro. 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 has rebounded quite sharply, to levels near 1.3000 form the sub-1.2700 levels that were seen last week. Oil prices, which had been looking ripe for a correction after a six-week rally that brought prices back into the pre-pandemic range, have corrected from fresh nine-month highs. News of a new, more transmissible Covid virus strain in the UK provided the catalyst for the correction in the reflation trade, with investors also apt to hedge exposures into the Christmas and new year holiday period. There are also oil market fundamentals to consider. OPEC supply is also set to increase in January, on top of the recovering supply out of Libya, while, outside OPEC, Norwegian and U.S. supply are also increasing, with recent price gains making production in the later viable again. There are also expectations for Iran to strike a deal on its nuclear program with the incoming Biden administration, which could lower sanctions that have been stifling oil exports out of the country. In the mix are signs that OPEC dissent is increasing, as highlighted by a recent Chatham House report, with multiple participants in the output quotas looking less likely to remain in compliance.