Currencies & Commodities Roundup
Updated: Mar 12
By Darshan Viswanath, Jeet Shah, Ryan Teo Zhi Kai, Gopal Modi, Maria Dupré, Max Trapnell, Oliver Armitage, Anshuman Bhatnagar, LSESU Trading Society
The pound has been one of the best performers in 2021, with those buying the dip around the new year currently sitting on a 5% return from the trade. Moreover, assuming the use of a typical amount of leverage for the FX markets, say 30X, and selling now, one could fund Lockdown Uber Eats and Deliveroo's for a long time. However, would this be sacrificing future gains? Is GBP reaching the end of a bull run?
Over the last 48 hours or so, the GBP/EUR bull run has wobbled, with the exchange rate falling 0.9% overnight from 1.1623 to 1.1519. On the one hand, the decline can be attributed to a simple correction after a sustained period of the currency running hot. Perhaps, Investors and speculators started to take profit as technical indicators started to suggest overbought conditions - The Relative Strength Index reached 80, having remained above 70 for half of February. Moreover, it's possible that the fall doesn't reflect changes in the fundamental sentiment towards GBP. Diminishing investor sentiment resulted in global stock markets dropping off, whilst similar bond selloffs saw yields rise. In the hierarchy of safe-haven assets, The Euro beats GBP, and so, a decline in the GBP would be expected.
On the other hand, it's also possible that confidence in the UK's economic recovery has waned. The FT Weekend's headline reads "Sunak Warns of Bill to be Paid to Tackle UK's Exposed Finances" – it hardly inspires confidence, particularly when the article goes on to discuss Sunak's planned corporation tax rate hike. The central bank has voiced fears over inflation, and reigning in its generous quantitative easing programme would cool down markets. Of course, there is also still much uncertainty about how the UK will position itself with regards to international trade when normality returns.
Despite this, I still feel confident that GBP/EUR will continue to perform strongly as the UK pursues its COVID exit strategy. The commitment to some 'irreversibility' for lockdown easing is reassuring to businesses, and the UK's vaccine rollout is still proceeding at a rapid pace, with last week's supply chain chink seemingly ironed out. The EU is still struggling with its own programme, with France facing issues over low uptake of the AZ vaccine following Macron's miss-grounded comments doubting its efficacy. Germany was facing similar problems when a prominent newspaper stated the AZ vaccine was only "8% effective in over 65s". It was later discovered that they had misread the study – 8% was the number of over 65s who participated in the AZ study. Moreover, Sunak remains committed to providing all the necessary fiscal support to keep businesses and people afloat whilst the economy gets back on its feet. Looking forward, the government's plans and initial steps for "levelling up" the economy will undoubtedly affect the performance of GBP/EUR. This starts with Sunak's budget next week.
Regardless, GBP/EUR has experienced an unprecedented level of volatility for G10 FX over the last few months. Seemingly gone are the days of boring 0.001% daily moves. A solid trader with good timing could extract a lot of value from the market at the moment. One would look to see how the price responds to contact with the trend line drawn – a breakthrough downwards would result in bearish price action, and a rebound off the trend line would suggest a continuation of the bullish run. Momentum indicators do not currently suggest overbought or oversold conditions.
Despite rising to 1.2241 – the highest price observed in the last month of trading – EUR/USD has slumped back, returning to the 1.2050-1.2100 price band the pair observed midway through February – a weekly loss of around 0.3%. However, while this week has had a depressing effect on EUR/USD, the pair's long-term direction is still up in the air.
While Boris Johnson's new 'roadmap' for the UK economy has spurred bullish sentiment in GBP markets, more dovish rhetoric on the continent this week has contributed to the recent bearish market sentiment within EUR markets. Lagarde's speech on Monday – in which she noted that the European Central Bank (ECB) was monitoring the recent rising nature of long-term European rates – has hinted that the ECB may adopt a looser monetary policy approach in the very near-term. Similarly, Yannis Stournaras called this week for the ECB to quicken the rate at which it is buying European bonds through the Pandemic Emergency Purchase Programme (PEPP). At the same time, Philip Lane reaffirmed the ECB's commitment to utilising its resources to avoid fiscal tightening's in Europe.
Markets will likely wait until Tuesday's PEPP data release to analyse whether any material change has occurred in the ECB monetary policy approach and whether any such modification is worthy of a reaction within EUR markets. Markets will then price in the ECB's rapid use of its PEPP funds in Q2 2020, showing the ECB's capacity and willingness to ramp-up its Covid-19-induced QE if needed. Regardless, the more dovish tone of ECB members in response to rising bond yields compared to their colleagues in the US has certainly helped to depress EUR/USD as investors seek to capitalise on the prospect of more-established US bond yields, with the 10-year nearing 1.374% this week - the highest yield since February 2020.
Conversely, the month-on-month US PCE price index came in slightly above expectations, at 0.3% (instead of 0.2%), perhaps helping ease the fall of the EUR/USD this week. Furthermore, as inflation continues to rise in the US towards 2% steadily, markets may increasingly focus on when the Fed will begin to raise rates to stem inflation – creating additional long-term bullish pressure within EUR/USD. Likewise, the House of Representatives passing of Biden's $1.9tr COVID-19 relief bill edges the prospect of inflationary pressure on the USD ever closer (even if the proposed $15 minimum wage proves to be a sticking point that ultimately is removed). This, in turn, will aid the strengthening of the EUR/USD market.
Looking forward, therefore, the drivers of the slightly bullish nature of the EUR/USD pair remain. However, in the weeks ahead, eyes will increasingly be focused on the ECB's actions in response to rising bond yields to see if they follow through on their increasing dovish rhetoric.
As observed on the 4H timeframe, XAUUSD has been on a sustained downtrend ever since approaching the recent highs of 1,960 per ounce in early 2021, forming lower highs and lower lows. Critically, it broke below the strong support level of 1,830 (Black Horizontal Line) in mid-February; and this level failed to turn into resistance in the days that followed.
Gold is traditionally seen as a risk-aversion and inflation-hedging asset. The increasing risk appetite of investors, stemming from an optimistic outlook of a global COVID-19 recovery and the recent runaway rally in the US Treasury bond yields, has put significant pressure on gold prices.
Increasing Risk-Appetite of Investors
The efficacy and efficiency of vaccination programmes worldwide have provided renewed optimism for accelerated economic recovery from the pandemic. World leaders, including EU Commission President Ursula Von Der Leyen, have also called for the donation of vaccines to less developed countries. The potentially reduced rate of global transmission will boost international trade, which has led to an underlying bullish tone in the financial markets.
This has prompted investors to reallocate capital away from traditional safe-haven assets, such as the dollar. With the trend in gold prices positively correlated with the dollar's strength, increasing risk sentiment does not bode well for the price of gold.
Gold Losing Favour as an Inflation-Hedging Asset
Bullish traders may point to reflation concerns in the US as a potential upward boost for gold. Admittedly, on Tuesday, US Federal Chair Jerome Powell had committed to an ultra-easy monetary policy stance (of retaining low interest rates), which has led to the fuelling of inflation expectations. Theoretically, this would lead to increased demand for gold, but realistically, it did little to impact the prices of gold positively.
This could be attributed to investors' preference toward the US Treasury bond yield as an inflation-hedging asset. An increase in expected inflation increases the nominal interest rate (nominal yield = real yield + inflation). This led to a rally in 10-year Treasury yields to 1.4%, the highest level since February 2020. Gold and bond yields are substitutes as inflation-hedging assets - it seems that investors have deserted gold in favour of yields in order to counteract inflation concerns.
The bearish bias of gold is expected to continue into the medium-term, bar increasing pessimism in the financial markets or a decline in Treasury yields. Technically, a successful break above the previous support-turned-resistance level of 1,830 will serve as preliminary indicators of a potential bullish reversal.
The second half of February saw a remarkable increase in oil prices, reaching pre-pandemic levels. This rally has been stoked by the expectation of a US stimulus boosting the economy and the optimism for a global recovery stemming from successful vaccine rollouts. Additionally, the recent snowstorm that hit Texas has caused refineries to shut, reducing US oil production by 10% and increasing demand at the same time. These factors contributed to oil prices trading at 13-month highs. Contributing to the upward trend, OPEC+ production cuts caused oil futures to break the $60/barrel level. This upward trend temporary reversed on the 17th of February, as declining US bond prices pushed yields up, strengthening the USD. Hence, US crude oil's relative cost increased for foreign buyers, pushing oil futures back below $60/barrel. Despite this short-lived decline, prices rallied again on the 23rd, with Brent Crude trading at a year high of $66.7/barrel. Oil prices set a new 13-month record high on the 25th of February before slipping on the 26th. This is due to the restart of the largest US refinery, Motiva Enterprises, and the markets expecting larger supplies being announced at the next OPEC+ meeting on the 4th of March, following the recent increase in prices.
EUR/USD currency pair ended Q4 of 2020 on a strong note, and this growth has continued well into February of 2021. The key drivers for this major exchange rate are the relative success of the EU and the US in handling the pandemic, the corresponding fiscal and monetary policy actions taken by two, and their economic data's relative strength.
1. Impact of Covid-19 and vaccination programme on EUR/USD
The Euro has been boosted due to improvements in the EU's coronavirus situation; in particular, the Week 7 2021 14-day COVID-19 case notification rate per 100 000 is avergaing 317 for the eurozone (lowest since week 43 of 2020, late October). This shows that the lockdown measures across many member nations have been effective, despite the economic area facing difficulties in its vaccine campaign. Fresh supplies of the vaccine delivered by AstraZeneca, which now plans to "double its output", have further bolstered the EU's post-pandemic recovery efforts. However, recent reports suggest that the general EU and, in particular, the German take-up of available AstraZeneca doses has been pitiful (where just 187,000 of the 1.5 million available shots had been used by the end of last week), suggesting fierce resistance to AstraZeneca. Reasons for this could include: the unseemly spat between the European Commission and the manufacturer over delayed deliveries, a lack of trial data for over-65s, thereby many national regulators limited the jab to under-65s, and Europe's "long and ignoble" anti-vaxxer tradition. Whatever the reasons may be, the diminished take-up of AZ vaccine in the eurozone is a threat to our long position.
On the other side of the Atlantic, despite having a smoother running vaccine campaign, the US 14-day COVID-19 cases notification rate per 100,000 has increased from 414 to 531 between week 6 and 7 of 2021; though, these numbers are still much lower than during the peak of the virus in early January.
Overall, the markets are becoming more optimistic about the global economic recovery. This is dampening appetite for safe havens like the US Dollar.
2. Impact of Economic data release on EUR/USD
Discouraging economic data releases in February have weighed in on the USD's appeal. While the Initial Weekly Jobless Claims were lower than expected (730,000 instead of the forecasted 757,000), this has to be caveated as the actual jobless claims could easily be larger than the expected 757,000 because of the deadly winter storm sweeping Texas and other southern states. Furthermore, given that each of the previous weeks' initial jobless claims was higher than expected in February, there's no reason to believe this week was any different from previous weeks. Moreover, weaker non-farm payrolls data from last week continues to signal weaknesses in the key US job market, favouring the Euro.
Meanwhile, the Employment Change report indicated that the number of employed persons in the Euro Area grew by 0.3% quarter-over-quarter in the fourth quarter of 2020. ZEW Economic Sentiment Index grew from 58.3 in January to 69.6 in February compared to analyst consensus of 57. Altogether, providing support to EUR/USD.
3. Impact of Monetary Policy direction and Fiscal Stimulus on EUR/USD
Fed Chairman Jerome Powell's dovish comments confirm that the interest rates would remain low for longer to stimulate the economy. He stated it "could take more than three years before inflation reached the Fed's target of 2%", which on the surface does assuage concerns that the Fed will not be hawkish in the face of accelerating inflation. Hence, the dollar is expected to depreciate against the Euro.
Though there are at least two threats to our position:
Dovish tone hinted by ECB: President Christine Lagarde said the ECB would closely monitor long-term interest rates, and ECB Governing Council Member Yannis Stournaras outright called for an increase to the pace at which the ECB buys government bonds to address what he called an "unwarranted tightening of financial conditions", signal more QE and thus potential strengthing of the dollar
Reflation trade prospect: the recently approved $1.9 trillion stimulus package could overheat the economy so badly as to be counterproductive. According to former IMF head and MIT economist, Oliver Blanchard, if the upper bound of the output gap is 900 billion, and the total increases in demand from increased American savings (estimated $800 billion), CARES ACT stimulus ($900 billion), and Biden Stimulus package ($1.9 trillion), in total equaling $3.6 trillion and if we assume a multiplier of 1, implies that the aggregate demand is 4 times the output gap. Thereby, the output would be 14% above potential and importantly, it would lead to strong inflation (much larger than the 2% target). So, there's a good possibility that the Fed will have to enforce a substantial increase in interest rate to fight off overheating. Naturally, higher US interest rates would weaken EUR/USD as European capital flows into the US.
Starting February 2021 at a low of 1.1952, the EUR/USD pair picked up the pace and is currently trading within a clearly defined upside channel, making higher highs and higher lows (as seen from the 4H chart above).
EUR/USD's RSI value of 33.01 indicates the market has nearly oversold the pair (indicating bearish sentiment). Given this and the fact the price action has bounced off the lower trendline three times, the current market price is an appropriate point of entry for our long position (buy on the dip type of situation) with a take profit at the level of 1.2350 providing insurance against a reversal of the upward trend above this level and against the uncertainty surrounding FED's monetary policy stance. Further, confirmation of the long trend can be seen via the Bollinger Bands, where we buy EUR/USD when the price action line touches the bottom band, which is three s.d below the 20-period MA line, depicted by the purple line.
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