Stronger “risk on” backdrop emerging as EU Recovery Fund deal takes shape, landing zone seen on Brexit, Australia details stimulus beyond Jobkeeper

Stronger “risk on” backdrop emerging as EU Recovery Fund deal takes shape, landing zone seen on Brexit, Australia details stimulus beyond Jobkeeper                                             

• EUR: Compromise EU Recovery Fund deal in the making may support further gains in the euro - EURUSD trades well at 1.1450, as it seems EU leaders seem to be on the cusp of a deal. Headlines point to a compromise deal by the “Frugal 4” – (Dutch, Denmark, Sweden and Austria) agreeing to EUR390bn in grants and EUR360bn in low interest loans with the total size of the package unchanged at EUR750bn. However, pending are details regarding surveillance, including rule of law concerns, in particular, the addition of a review facility  should it look like the funds are being used for transfer payments rather than investment. Dutch PM Rutte is supposedly insisting on a single country veto but Citi analysts see this is as unlikely. A more plausible scenario may be checks and balances with some conditionality that guides how recovery aid is spent.                   

• EUR: What this means for EUR? The reported compromise deal likely removes the short term downside risk of failure and ultimately underscores low euro zone breakup risk. This means in a risk-on cyclical recovery, EUR-denominated assets can continue to see rotational inflows and EUR likely remains a “buy on dips”. The agreement still leaves a protracted ratification process that is unlikely to come until Q4’20. However absent a complete failure of ratification, tweaks along the way are unlikely to be a game-changer for EUR. Broader drivers of EUR therefore remain unchanged - (1) fading breakup risks, (2) bid for cyclical assets, and (3) re-allocating towards Europe.

• GBP: Brexit: In recent weeks a landing zone seems to be emerging in EU – UK Brexit negotiations whereby the UK rejects many of the more stringent level playing field arrangements in return  for allowing the EU greater capacity to re-impose barriers if divergence is realized. This would likely still likely have a negative short run impact on the UK economy, weighing on growth in 2021. A skeleton of a deal will likely be needed by the early autumn if a deal is to be reached.  

• AUD: Australian Federal Government Budget update - JobKeeper and JobSeeker extensions - the Australian Budget Update from Treasurer Frydenberg on Thursday will likely include an extension of the government’s income support programs of JobKeeper and JobSeeker past their September deadline. Recall that the Treasury amended its costing of JobKeeper from AU$130bn to $70bn because of better than expected health outcomes. It is more likely that the government will announce an extension of JobKeeper past September—at least till the end of the year. This likely adds to the positive risk tone and support for AUD.                       

USD & GBP: More drivers of positive risk sentiment this week other than EU’s Recovery Fund/ Brexit progress    

• Positive vaccine news – UK researchers announce that they are seeing T-cell responses induced with neutralizing antibodies generated in more than 90% of healthy adults recruited  across different assays. A second dose is seeing participants produce the antibodies and phase trials III have now begun. A UK based biotech company says it is also showing positive preliminary results for a specific protein with patients who receive this having had a 79% lower risk of developing severe Covid-19 compared to placebo, according to its statement. The company however reminds readers these are preliminary results. Finally, a major US drug manufacturer also provides an early update for their vaccine candidate in Phase I/II with a promising antibody and T-cell response in 60 participants. Bottom Line - Market reaction to this news is limited, reflecting expectations but also a reality that there is still a long way to go. The most critical clinical trial stage is likely Phase III, which establishes whether the vaccine candidate effectively protects against infection – these trials have only recently begun.    

Fiscal policy likely takes center stage in the US this week                                          

• USD: Citi analysts expect the US Congress to agree to a phase – 4 stimulus of USD1trn. Republicans, on the other hand, are yet to present a formal plan but as per Treasury Secretary Mnuchin’s comments, the Republican plan will likely include a payroll tax cut. This guidance comes post a meeting with Republican Senate Majority Lead McConnell, GOP leader Kevin McCarthy and President Trump. More headlines are expected ahead as Mnuchin is scheduled to talk with Democratic House Speaker Pelosi, Democratic Senate Minority Leader Chuck Schumer and White House Chief of Staff Mark Meadow tonight.                  

• USD: How long is likely the wait? Republican Senate Majority Lead McConnell advises that its party’s plan will “hopefully” come “as early as this week.” But the payroll tax cut, although being discussed by the White House, has received little traction in Congress and while it cannot be ruled it out, it is unlikely to be part of the bill. This could drag negotiations for a bit longer.       

Asia EM: Factors supporting a stronger RMB           

• CNY: Better than expected Chinese data, PBoC’s reluctance to ease, and strong equity momentum may strengthen CNY in coming weeks/ months - in January, USDCNY was likely weighed by seasonal corporate selling flows that saw a low of 6.85. However, spot gapped up above 7.0 after Chinese New Year due to the breakout of Covid-19 in China. The rest of Q1 was dominated by a poor risk tone with a mixture of weak Chinese data and the onset of the virus around the world.           

• CNY: In Q2, USDCNY consolidated in a 7.05 - 15 range but now in Q3, stronger equity momentum has seen a record RMB54bn (US$8bn) of Northbound flows while Southbound flows have also picked up to RMB20bn (US$3bn) month to date. In addition, a more contained Covid-19 outlook in China together with better than expected economic data may start to put pressure on USDCNY to weaken (CNY to strengthen).   

This is is an extract from the Daily Currency Update, dated July 21, 2020. Please approach a Citigold Relationship Manager if you would like more information.