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SystematicEdge FX Commentary October 2020

15 October 2020

USD: Long-term bearish trend

The currency market is at an inflection point. Major upcoming events and risks may reset the relative levels of currencies going forward: the US elections, the second wave of the pandemic, the US and China’s on-going economic trade war and Brexit. In our currency valuation analysis we don’t aim to predict currency as we know currencies follow a random path, yet we can witness their secular (long-term) trends and  dynamics. Our goal is to explain currency drivers and their trends set by fundamental economic data which can, however, be disrupted by geopolitical events.

The US structural twin deficits, combined with fundamental and geopolitical factors, are negatively affecting the USD in end-2020 and 2021:

Nonetheless, USD remains a safe haven, as the US is still the only superpower. When negative events such as the Covid pandemic arise, the first reaction from investors is to buy USD and get rid of most of the other currencies (with the exception of CHF and JPY). Consequently, the USD haven status can temporarily trigger short-term trading rallies. 

Other currencies versus USD

USDCNY bearish (CNY bullish), range [6.00 ; 6.80]

The trend for CNY is bullish given China’s solid economic growth and positive balance-of-payment dynamics as well as the yuan’s attractive interest rates yield curve above 2%.

This year, investors substantially increased their positions in Chinese government bonds, which has supported the CNY.  The CNY rallied as investors bought Chinese equity and debt amid signs of a faster and sustained economic recovery.

US Dollar Chinese Yuan
US Dollar Chinese Yuan (chart above)

EURUSD: bullish trend with a target at 1.25

The 1.16 resistance was broken in July, and EURUSD has remained above it since then. The Euro is benefitting from USD weakness. In addition, for the first time, the EU has issued Euro supranational bonds with the ECB as the major buyer, which reflects a strengthening of the Eurozone governance generating positive sentiment and has increased investor trust in the Euro. This has underpinned the Euro’s bullish trend with a target at 1.25, close to its Power Purchase Parity of 1.27. EURUSD becomes vulnerable if the second Covid wave gets out of control in Europe.

Euro US Dollar (chart above)

AUDUSD volatile, range [0.68;0.74]

Australia’s central bank is expected to keep interest rates close to zero while the government’s fiscal program will be announced this week. The Reserve Bank of Australia will incrementally lower the cash rate and buy longer-dated government bonds as it continues to keep its monetary policy accommodative in the aftermath of the Covid-19. This will add downward pressure to the Australian dollar and limit the currency's upside in 2021.

Australian Dollar US Dollar (chart above)

GBPUSD volatile, little visibility till Brexit negotiation is over, range [1.2675 ; 1.35].

We expect some type of Brexit deal before year end, which will be positive for the GBP. However, a hard Brexit will send GBPUSD below 1.2675. The GBPUSD PPP is 1.53 so at this point in time the pound is about 20% undervalued.

British Pound US Dollar (chart above)