FX Update: Pivotal week ahead with FOMC, UK election and US-China trade talks

Markets are in a buoyant mood coming into this week on the narrative that the global economy is stabilizing and that the central banks have opened the taps for maximum liquidity – particularly in the Fed’s case to avoid any liquidity mishaps into year end. Since the first of September, the Fed has expanded its balance sheet by some $300 billion. The messaging from the Fed around how it views the ongoing expansion of its balance sheet could prove the most pivotal takeaway from the FOMC meeting on Wednesday, as the prior meeting made clear that the Fed wants to pause on cutting rates for now. The blowout November US jobs report on Friday makes it easier for the Fed to justify the pause.

But the most pressing issue looming over this market is the fate of the US-China trade negotiations, the never-ending story that now finally requires a concrete decision – even if just a punt/delay – because of the approaching December 15 implementation date of the last round of US tariffs. China, meanwhile, sent an interesting message over the weekend in ordering its public sector to eliminate all foreign suppliers of computer equipment, an obvious move against US tech giants.

Ahead of the UK election, the consensus strongly points to Boris Johnson’s Tories sustaining a sufficiently large lead to realize a majority Tory government. The Guardian measure of polls shows the Tories with a 10% lead on Labour, though as my colleague Ole pointed out on this morning’s Market Call, tactical voting is a risk, not to mention that the unusually large LibDem popularity (as a Remain vote) is a complicating factor. Sterling is strongly bid again this morning, but would be surprised to see a significant extension ahead of Thursday. In the options market, the skew is strongly negative, i.e., the market knows that the side with the most volatility risk over the election is to the downside on an election shocker (hung  parliament leading to more delay, etc.).

The US and Canadian jobs reports on Friday provided a massive contrast that caught USDCAD shorts (on the back of a less dovish Bank of Canada meeting on Wednesday) the wrong way around. Canada’s unemployment rate leapt an eye-watering 0.4% to 5.9% in just one month. Even if the data series is choppy, this is a weak development that bears further watching.

Chart: EURUSD
After recently posting record low implied volatility for every major option time horizon, EURUSD is potentially pivotal over the US-China trade negotiations outcome potentially far more than over the FOMC and ECB meeting this week. Ugly outcomes that see the December 15 round of tariffs going into effect are potential EUR negative as the EU is the most dependent bloc on exports, especially to China. Technically, a failure below the recently pivotal 1.1000 is the first sign of a fresh breakdown, while bulls at this point really need that strong surge above 1.1180 to suggest the pair is finally on the move to the upside.