FX Daily: Pause In USD Bear Trend, Not A Reversal

Given that the rise in Covid-19 cases is worrying, yet not detrimental to economic prospects, there is large stimuli in place and the market continues to take a glass half-full approach, we are inclined to see a pause in the risk rally and the dollar's decline, rather than a material reversal.

USD: Pause in USD bear trend but not a reversal

The markets are currently weighing two opposing forces for risk assets. The rise in Covid-19 cases in the US and China and its associated risk for the economies, and stimulus measures (both monetary and prospects of further fiscal). On the latter, the Fed will begin purchasing individual corporate bonds under the secondary market corporate credit facility. Given that: (1) the rise in Covid-19 cases is worrying, yet not detrimental to economic prospects; (2) the large stimuli in place; and (3) the market continuing to take the glass half-full approach, we are inclined to see recent developments as a reason for a pause in the risk rally and pause in the bearish USD decline, rather than a material reversal of the prior risk asset gains (both in the equity and FX spaces). Within the G10 FX space, and despite the recent rally in procyclical currencies, most of this FX segment remains undervalued vs USD, based on our BEER model (with the exception of the Canadian dollar, which is close to its fair value, though still modestly below it), suggesting few reasons for a fundamentally justified turn in the dollar. The same applies to emerging market FX, where the majority of currencies remain cheap vs USD. (UDN)

EUR: Limited scope for two-way price action 

With the USD bear trend on hold, the EUR/USD upside should pause too, and the pair should range trade around 1.1300 today. The positive effect of European Central Bank measures on the euro is now fully in the price and another leg of USD weakness is needed to send EUR/USD above 1.15. This does not appear imminent at this point. (FXE)

GBP: Dip in May UK Inflation a non-event for GBP

The dip in May UK Inflation was in line with expectations and is unlikely to weigh on sterling via a more dovish market expectation channel. The key for negative rate prospects remains the UK-EU trade saga and we don’t expect much progress to be made in coming weeks. The near-term GBP upside thus remains limited and our bias is for higher EUR/GBP (to 0.91) in coming weeks. (FXB)

BRL: Cautious, but not a hawkish signal from BACEN

We and the market call for the Brazilian central bank (BACEN) to implement an additional 75 basis point rate cut today, bringing the SELIC policy rate to a record-low of 2.25%. The chief focus will be, however, on the BECAN forward guidance. As per Brazil: A monetary policy test for the BRL, given the heightened uncertainties and the deeply recessionary outlook for the domestic economy in the nearer term, the most likely outcome is for BACEN to signal caution, but not close the door to further rate cuts (even if a hawkish message of no more cuts would be the preferred outcome, in our view). A cautious message should be neutral for BRL today and keep USD/BRL below 5.3000 today.