Post date: 28/09/2020 12:58

The overhang of speculative dollar shorts finally brought about a sharp countertrend move in the currency last week. Risking risk aversion, falling stock markets worsening COVID numbers in Europe provided the perfect background for a significant short-covering rally in the greenback, which rose last week against every major currency worldwide. The sole exception was the Turkish lira, which managed a small rebound as the central bank there bowed to reality and hiked rates to combat inflation.

A hard-to-gauge factor in the increased uncertainty and risk aversion is fears over the outcome of the US presidential election in November, particularly the possibility of a disputed election. Our view is that so far it has had a modest impact, and the main reason for market nervousness has more to do with the second COVID wave in Europe and the inevitability of some sort of correction after the scorching rally in risk assets through the summer. The key macroeconomic date this week will be the US September labour market report and the Eurozone flash inflation estimates, out on Friday and Wednesday respectively. Until then, we will be paying close attention to the daily contagion figures in key European countries to see if the second wave starts to break.


Sterling performed better than most of its peers last week, though it still notched modest losses against the US dollar. The possibility of negative rates from the Bank of England has receded somewhat, although we did have some dovish comments from MPC member Tenreyro over the weekend. The market also acted favourably to the unveiling of the UK government’s ‘job support scheme’ last week, despite the programme drawing criticism domestically. Meanwhile, hopes for a last-minute deal on Brexit persist. Our central scenario is still some sort of de-minimis deal at the last minute, which means sterling is likely to flop around current levels vs the US dollar while perhaps rallying modestly against the euro.


Disappointing PMI business activity numbers for Septembers added to the general sense of gloom that has settled over the Eurozone prospects over the past two weeks, mostly driven by the second wave of Covid contagion in the continent. The only significant release this week will be the flash inflation report September, after the negative shock of the previous month. We do not expect a rebound from this all-time low. Also, the overhang of speculative bets on the euro has not yet cleared significantly. While we remain positive on the common currency over the medium-term, we would not be surprised to see the struggle somewhat this week.


Last week made it clear that the dollar is far from losing its appeal as a risk haven. The general flight to safety resulted in a sharp rally in the greenback, with the currency helped by the continued easing in new daily US virus numbers. The rally in the dollar last week was actually its biggest weekly gain since near the peak of the pandemic in April. The weaker than expected weekly jobless data did not seem to affect the dollar, but we see some risk that a similar negative surprise in the critical monthly report Friday afternoon may have a more lasting impact. Headlines regarding the potential passage of a scaled down stimulus bills are likely to drive markets until then.