FX Update: Would a Covid-19 vaccine bring USD weakness forward?

Yesterday, I indicated a struggle with the weak USD narrative based on the US election result, but the news of a possible Covid-19 vaccine could dramatically ease and bring forward the path to a weaker US dollar for the following reasons:

• Pent-up US savings – The US private sector stockpiled a large portion of the incredible stimulus blitz – by some estimates, some $2 trillion. If a path is open to fully reverting to “normal” pre-Covid-19 behaviour, this consumption would help drive enormous external deficits as the US imports a high percentage of its consumption basket.
• US Treasury has significant funds at the ready for stimulus – the Treasury has piled up over $1.5 trillion as it raised more money than it needed during the panic phase of the pandemic last year. The release of these funds will improves USD liquidity further as some form of stimulus will have to be forthcoming under a Biden administration to avoid a cliff-edge on some of the CARES act after December 31 and to prevent business closures. Also, given that the Treasury already has a good deal of stimulus money at the ready, it will mean that reduced fiscal stimulus after this winter and possibly spring made possible by a Covid-19 vaccine would mean a reduced need for US Treasury issuance, likewise a boost to USD liquidity.
• Fed will still prove slow to respond to rising inflation: With its new flexible average inflation targeting (AIT) regime, the Fed has promised it will be very tardy to respond to inflation eroding the value of the US dollar. At the margin, here is the additional risk that the Fed moves against higher US yields if the treasury sell-off deepens, fearing that higher rates will slow the recovery in the US labor market. If the Fed threatens yield caps, or yield curve control (YCC), this would crystallize the USD bears’ strongest argument: the erosion of the USD value on negative real rates. (Yield curve manipulation can come in many forms, in a soft way via QE purchase weightings or more explicitly in new YCC guidance).

Chart: EURGBP
EURGBP has rushed lower despite no notable development on the Brexit negotiation front today as it seems the Covid-19 vaccine story is the chief driver here for an economy that has been devastated by the virus. The price action had been bottled up near the pivotal 0.9000 recently until today, when it rushed lower, as a Covid-19 vaccine hope would lift the very heavy clouds that have hung over the UK economy since this spring, also likely banishing any thoughts of a negative rate policy from the BoE.

The G-10 rundown, express edition

USD – discussed above, not convinced USD upside gets much traction even in short term unless market volatility goes truly ballistic. A clear path to a Covid-19 vaccine brings forward a weaker US dollar.

EUR – if the Pfizer and other drugs continue to bring promise, great news for EUR, although strength could be modest as pro-cyclical beta is lower than for commodity- and EM F.

JPY – the action is in cross-JPY (yen weakness) more than USDJPY as long as market celebrates an improved global growth outlook.

GBP – need that  Brexit breakthrough headline – and if Covid-19 vaccine hopes are sustained, EURGBP could have room for 0.8600 in short order, while 1.3500 is the big focus for GBPUSD, freeing up possibly 1.400.

CHF – the Swiss franc punished as global yields spiked higher and safe haven gold out of favour. If we can get post-Covid-19, post-Brexit and a solid EU fiscal package, may be room for a larger adjustment higher in EURCHF. For now, the 1.0900 level is the next hurdle.

AUD – if risk sentiment continues higher, AUD is well positioned for a post-Covid-19 boom if that is where we are headed.

CAD – USDCAD is teasing the major 1.3000 chart point – a deepening hope for a global recovery would open the path lower (stronger for CAD).

NZD – RBNZ is up tonight – and an interesting one. Expect “funding for lending programme” on track, but on the guidance, some chance for a hawkish shift as Governor Orr and company might want to extend the potential horizon for bringing a negative policy rate – or introduce doubt that they will go negative at all, given that the next couple of months could see the deepening promise of a Covid-19 vaccine.

SEK – the weight of Covid-19 on Europe lifting would be a huge boon for SEK, hence EURSEK already teasing below 10.20 at times today and ready for a try toward 10.00 if sentiment backdrop remains positive.

NOK – the path is open to the 10.36 range low in EURNOK and possibly more if oil can break above 46/barrel and the hopeful backdrop is maintained. Epic chart line in USDNOK don around 8.75 (price currently at 9.00).

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