The Investment Bank Outlook – 07-09-2020

Overview: Friday afternoon brought interesting price action in FX markets: the US fixed income sell-off post the US job report initially brought USD strength dragging EUR/USD below the 1.18 figure. Meanwhile, within a few hours the greenback lost its gains and EUR/USD ended the session roughly flat. Scandies were also little changed vs the EUR while AUD, NZD and CAD were among the modest winners.

Majors: For EUR/USD, a key theme remains ECB’s verbal intervention last week. However, we do note that the effect of verbal intervention in FX is rarely very persistent (cf previous episodes in EUR/HUF, CHF, TRY). Given that we do not expect a policy change from the ECB, we like to fade the effects of such verbal intervention. Rather, keep in mind (1) we think the FX impact on euro area inflation is low, (2) the global trend of a synchronised recovery is likely to continue, and (3) next week we look for further dovish action from the Fed. These points remain in favour of a renewed test of 1.20 for EUR/USD near term. Brexit negotiations continue this week but without any expectations of any breakthrough. GBP has been fairly resilient to ongoing pessimistic comments from both sides, and EUR/GBP is now trading around 0.89. That said, we do not see the case for further GBP strengthening near term, given Brexit talks are about to move into final stages.

UBS: Brexit big scoop by the FT last night, reporting that the UK is planning legislation for this Wednesday that would override key parts of the Brexit withdrawal agreement. If so, the current negotiations would be seriously threatened as the EU would likely conclude that the UK is not acting in good faith. The biggest sticking point in whether or not a deal is possible has become the so-called level playing field, i.e. state aid. The withdrawal agreement has language binding the UK to EU rules on state aid, but Boris Johnson appears to want full freedom to subsidize industries, including for example the tech sector, which EU rules do not allow. I’m surprised by the muted reacted in sterling, but would expect it to accelerate if the FT story were to unfold as described, threatening a collapse of Brexit negotiations.

BNP: Tech stocks sold off again overnight (Nasdaq 100 sep. futures -1.3%), but G10 FX traded in tight ranges. Further risk-off price action this week could challenge our bearish USD view in the near-term but we think risk-reward heading into the ECB is sufficiently compelling to stay long EURUSD.

ECB meets on Thursday. We think the FX market has adjusted too much relative to our expectations of no action by the ECB. Dovish language with no concrete action could reinforce the market’s perception that the ECB has limited tools to counter EUR gains. As a result we think a sustained break of 1.18 in EURUSD is unlikely. Further ECB pushback against a strong EUR will likely have diminishing impact over time as the lack of ECB ammunition becomes more apparent. In addition, Lagarde will be wary of going much beyond Lane’s rhetoric and pushing actively against a strong EUR in light of the U.S. administration’s focus on FX manipulation.

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