Morning Commentary: Relentless Optimism

Foreign Exchange - Morning Commentary
Relentless Optimism 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Market action over the past couple of weeks reflects a level of sustained optimism that has caught many by surprise.  This past week saw a broadening and accelerating rally in cyclical currencies, to the detriment of risk hedges such as the USD, JPY and CHF, as economic data surprised to the upside.  Altogether, the USD index has given back ~70% of its March rally.    

One of the more notable developments was the ECB’s large expansion to its Pandemic Emergency Purchase Program (PEPP).  To an extent, the euro’s rally is understandable as the ECB’s action relieves pressure on sovereign risk concerns.  But at the same time, it is interesting to see how readily the markets were willing to ignore ramifications of an ECB QE program that will be ~15% of GDP this year and potentially hit a “best in-class” 23% of GDP next year.  

On a broader level, the bullish skew to which markets have been interpreting all near term catalysts has been nothing short of surprising.  Investors appear to be content to buy simply based on the fact that economies are re-opening while brushing aside any concerns around quality of post COVID-19 growth.  

Additionally, the speed at which markets have embraced a shift in secular themes has been stunning.  Valuation concerns over the USD due to the growing twin deficits have long been ignored until recently.  Moreover, the markets seem to have made a swift pivot on its view of the euro as a potential challenger to the USD.  While increased political will to accept fiscal transfers is welcomed, the willingness from markets to extrapolate a few incremental steps into a full blown fiscal union can only be described as very optimistic.      

Many factors, including those above, puts uncertainty around the sustainability for the current trend to continue into the medium term.  Nevertheless, there is no denying recent price action and there is a lack of catalysts to make the markets rethink its current pro-growth/anti-dollar stance.  The next couple of weeks/months should continue to bring improved data as economies continue to re-open with evidence of potential long term COVID-19 scarring unlikely until late 2020 or even 2021.  Moreover, markets won’t have to deal with what happens once stimulus stops for a long time.  

What all this nets out to is a tactical bias for further USD weakness in the near term while still maintaining reservations around arguments for structural USD weakness.  
  • OPEC+ agreed to a one month extension of its pandemic driven production cuts.  The group also implemented stricter monitoring methods of its members to control issues with members producing more than agreed.  
  • German industrial production came in worse than expected at -17.9% MoM against expectations for a -16.5% decline.  
  • China’s trade balance came in better than expected as imports contracted sharply and exports expanded more than expected. 
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