Morning Commentary: The U.S. Dollar’s Vaccine Immunity
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
The U.S. Dollar’s Vaccine Immunity
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Andrew Kositkun Foreign Exchange Head Trader
For two consecutive weeks, markets received positive COVID-19 vaccine news. Clearly, the view that a vaccine breakthrough will be supportive of economic confidence is not a controversial position. Because of this, a vaccine most likely does not change many investors’ base case expectations for next year, as a large majority of them were already expecting a vaccine at some point in 2021.
What the recent vaccine news does is eliminate the tail risk of no vaccine and growth being sporadically interrupted by sequential COVID-19 infection waves. As a result, markets are now better able to look through the second COVID wave and weak fourth-quarter GDP in Europe and other parts of the world. The question then is why hasn’t this good news for the global economy led to greater U.S. dollar (USD) weakness? After all, the USD is one of the most anti-cyclical currencies.
The USD’s range-bound trading since the beginning of last week can be attributed to a few factors that helped avoid a sharp move lower for the dollar despite other asset markets re-pricing aggressively. In this regard, here are three of the more important mitigating factors:
USD valuation. The USD index was already 2%-3% lower than where current levels of global growth would suggest, reflecting the market’s expectation for a massive fiscal spending package from a blue wave. The markets didn’t have a chance to fully price out a blue wave (USD stronger) before positive vaccine news (USD weaker) hit. In essence, the sideways movement of the dollar may simply reflect the offsetting implications of an under-delivery on fiscal spending and an over-delivery or early delivery on a vaccine.
USD positioning. While USD shorts were trimmed ahead of the election, short USD was still the market’s consensus-held trade. As a result, the USD didn’t move as much as other asset classes, such as value stocks, which benefited from the rotation from growth into value.
U.S. Treasury yields. The 10-year Treasury yield is currently around its highest levels since June. Granted, it is still premature to say that yields will move definitively above 1%, but it would also be remiss to completely dismiss the possibility that the current rise in yields could challenge the low for much, much longer narrative that has been behind the dollar’s selloff following the initial COVID-19-driven spike higher. Keep in mind that 10-year yields incorporate Fed policy expectations over the next 10 years. Should everything go well with the economy and the pandemic, it would not be unreasonable to see a hiking cycle in 3–4 years.
To be clear, these factors won’t necessarily prevent the USD from weakening against more cyclical currencies when a vaccine is available, but they do complicate the timing of when USD weakness will come.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
Pfizer and BioNTech’s vaccine has been shown to be 95% effective in the final analysis of its major trial. Additionally, the companies have been working to accumulate two months of follow-up safety data on volunteers who had received the full two-dose regimen of the vaccine. With a key safety milestone reached, an emergency-use authorization from U.S. regulators can now be applied for. While this is good news, until a vaccine becomes widely available, there is little alternative to more restrictions in Europe and the U.S., where case numbers and hospitalizations remain high.
U.S. stimulus talks are back, with news reports indicating that House Speaker Nancy Pelosi and Senate Minority Leader Chuck Schumer have asked Senate Majority Leader Mitch McConnell to resume talks. Key issues include state and local aid and the size of the package. Given the election results, McConnell may feel he has the upper hand, and the White House has pretty much removed itself from the negotiation process. Further complicating the situation are January Georgia runoffs that will determine the fate of the Senate.
The White House is pushing to impose additional restrictions on Chinese companies trading on U.S. stock exchanges. The Securities and Exchange Commission is currently considering regulations to delist companies that do not comply with auditing rules. While these new rules are unlikely to be completed anytime soon, their use will likely depend on the Biden administration’s take on the U.S.–China conflict, for which there is wide bipartisan support to pressure China.
The British pound continues to be supported by positive Brexit news. These headlines include indications that a deal could be reached as soon as next week, reports that the French are easing their stance on the fishing rights issue, and a new EU briefing on Brexit scheduled for Friday.
Wage growth in Australia decelerated to 0.1% quarter over quarter, resulting in the slowest quarterly and year-over-year growth on record. Key employment data is scheduled to be released overnight, as wage growth is likely to remain subdued amid elevated unemployment.
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