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USD weakness - the gift that keeps on giving

USD: On a trade weighted basis, the dollar continues to drift to new lows for the year – consistent with seasonal patterns. The move is a shot in the arm for the global economy, effectively exporting low US interest rates around the world. Arguably you could say that the weak dollar and strong EUR/USD did contribute to the ECB’s dovish round of policy actions yesterday. Central to the dollar bear trend is the combination of recovery hopes (and rising inflation expectations) set against a Fed prepared to run the economy hot - this delivering deeply negative real US policy rates. This strategy seems to be working. On the former, US inflation expectations derived through indexed US Treasuries are on their high of the year at 1.90% - also look out for inflation expectations in the University of Michigan survey today. With Congress struggling to progress a bi-partisan stimulus bill, we expect the Fed to stay dovish. Brexit and a lack of US fiscal stimulus look the two key risks to the dollar bear trend near term.

CAD: The CAD is a little softer on the day, reflecting the weaker risk tone, but maintains a modest gain on the week overall. We do not think there is much the BoC can (or will do) in direct response to the CAD—whose recent gains have reflected the broader decline in the USD, have been orderly, and do not look out of line with underlying fundamentals. While the CAD tone remains highly contingent on the broader risk tone in the short run, we think the exchange rate is close to fundamental fair value around 1.27-1.28 at present.

EUR: The approval of the EU budget/recovery fund and Brexit had been two key factors holding the EUR back and fortunately the former has been resolved. The EUR750bn recovery fund backed by joint debt looks a big positive for the European project. With regards to the ECB, as Petr Krpata noted yesterday, it was hard for the ECB to beat dovish expectations. The verbal intervention of watching the exchange rate ‘very carefully’ likely will not be enough to put a lid on EUR/USD, since the ECB can’t back that threat up with FX intervention and looks in no mood to cut rates. The ECB can only hope to slow the EUR/USD rally. Were it not for the threat of hard Brexit, EUR/USD would probably be near 1.23 now based on global dollar trends. We could still see 1.2220/40 today.

GBP: UK asset markets are taking the threat of a No Deal Brexit far more seriously, evidenced by a large fall in Gilt yields. More tough talk can be expected today ahead of a Sunday deadline.

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