EC December Monthly

The end of the annus horribilis is at hand, and despite the hard winter ahead for the northern hemisphere, there is a sense of optimism for the new year. The first generation of vaccines for the coronavirus appears promising. The US has elected as president a person who is within the internationalist tradition. The UK's standstill agreement with the EU will still expire at the end of the year, but many are still hopeful a last-minute deal can still be struck. China has entered into the large regional free-trade agreement and allowed the yuan to appreciate by considerably more than even yuan bulls like us imagined. The yuan's year-to-date gain of 6% rival the Bulgarian lev as the top performer among emerging market currencies through November. It will the yuan's first annual increase since 2017 when it appreciated by a little more than 7%. 

The prospect that the Covid-19 can be brought under control spurred a shift in portfolio allocation. On the one hand, market breadth increased, and on the other, value overperformed growth. The Russell 2000 in the US rose over 17% last month, easily besting the NASDAQ and S&P 500. Among the major equity markets, Japan is seen as a "value play" as price-to-book multiples are around a third of what they are in the US. Foreign investors have returned to being net buyers here in Q4 (~$16 bln) after having sold around $83 bln of Japanese shares in the first nine months of the year.  

The backing up of bond yields that one would expect in the reflation trade has arguable been kept in check by expectations that both the Federal Reserve and European Central Bank will do more to support the bond market at policy meetings in December. The ECB has all but promised to expand and extend its Pandemic Emergency Purchases Program by several hundred billion euros (400-600 bln) and offer new attractive loans at an interest rate of minus 100 bp provided certain lending targets are reached. The Federal Reserve is expected to shift its purchases toward the longer end of the curve. There is some speculation that the Fed may increase the amount of Treasuries it is buying (currently $80 bln of Treasuries and $40 bln Agency mortgage-backed securities a month). Given some official comments, there may not be a majority that favors an increase now.  

The prospects of a vaccine that could allow a return to a new normal is seen as negative for the dollar. Those currencies that tend to do well in periods of robust growth, the Antipodeans and Scandis shined in November. The JP Morgan Emerging Markets Currency Index snapped a three-month decline with more than a 1% increase. Rising commodity prices, driven in part by strong Asian demand (especially China), were particularly helpful for Latam currencies. The Colombian peso and Brazilian real were the best performers, up 7.5% and 7.2%, respectively. Turkey's apparent adoption of orthodox monetary policy triggered a short squeeze that lifted around 12% in the first few weeks before the gains were halved in the second half of the month. Still, its 6.7% gain in November was only the second monthly rise since the end of Q3 19.  

Our longer-term view that the dollar's third significant rally since the end of Bretton Woods is over remains intact, and we expect the greenback to decline in 2021 as we expected in 2020. However, more immediately, the US economy's resilience leaves the dollar with scope to firm into the end of the year after its broad decline in November. Still, it is likely to remain rangebound against most of the major currencies as it has since early Q3.  

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Read more by Marc on his site Marc to Market.

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William K. 1 month ago Member's comment

Quite a thorough report covering a wide area.