FX Update: Markets grinding their gears to start the week

Today’s FX Trading focus:

Markets grinding gears to start the week
The weak US jobs report didn’t yield much of a market reaction – even if it was a rather ugly report. The November nonfarm payrolls growth was the weakest for the cycle at only +245k jobs (and a lot of that number is based on statistical assumptions) versus +460k consensus expectations, while the drop in the unemployment rate to 6.7% from 6.9% was spoiled by the fact that the participation rate likewise dropped 0.2% to a lowly 61.5%. The market quickly brushed aside the figure and US treasuries ended the day sharply lower while the major US equity averages posted a new all time high close. Supposedly, the good cheer was on the prospects that a stimulus package will make its way through the US Congress soon since the Covid-19 numbers are raging at their worst yet in the US and demand a response.

But even with news that a US stimulus deal could be agreed as soon as today, markets are stumbling out of the starting gate to start the week. Some of the negative sentiment may be on the fresh signs of geopolitical tensions between the US and China as the former threatened sanctions on further individuals linked to China’s Hong Kong policy moves. “Profit taking” is just as likely a reason for the cautious tone in the Asian session, and the rejection of a significant portion of Friday’s developments this morning (yields backing off sharply and equity futures wilting, even if the US dollar is following through higher) suggests that we shouldn’t read too much into the Friday close. The greenback has a bit more room to run higher here without breaking things – but EURUSD, for example, needs to stay north of 1.2000 post-this Thursday’s ECB, for example, to keep the technical argument of a USD breakdown intact.

Brexit risks more severe than anticipated?
More seriously impacting markets in early European hours seems to be the fresh concern that ominous clouds remain over the Brexit negotiations, with reports of progress over the weekend on fisheries denied by the EU’s Barnier this morning. I still think this ends in some sort of agreement, at worst some vague agreement in principle that is actually a fudge to continue negotiating final terms but is declared as a deal by Boris Johnson to appear that the box has been ticked. However, while markets seem primed to pile into sterling on the announcement of a breakthrough before this latest sell-off, it now appears investors have been caught very much off-guard. I have long maintained that any sterling resurgence on a smooth Brexit could find a rather low ceiling, while wanting to keep an open mind on the risk that sterling still risks considerable further long term downside on its structural weakness and isolation and external deficits.

Regardless, EURGBP downside over the next six weeks through options is the preferred method for trading the friendliest of outcomes from this point, while GBPUSD puts out into March or beyond next year are a way to trade a post-Brexit hangover. After all, many of the same long-term bearish factors for the US are the same for the UK – if not worse, with the only offsetting factor the fact that the UK currency is already rather weak, if less so than it has been in the past. The UK runs an even large current account deficit as a percent of GDP, the BoE is aggressively de facto monetizing debt, and the financial services industry that kept sterling over-priced in past cycles faces a permanent downsizing.  Oh, and sterling is no reserve currency of note and likely to continue to lose out at the margin as a percentage of global FX reserves in coming years.

Chart: GBPUSD
Cable edged above the huge 1.3500 level on Friday briefly as the US dollar traded at its weakest level for the cycle before bouncing back after the weak US jobs report. But now sterling has fallen out of bed to start the week as the weekend produced insufficient progress despite highest level talks between UK Prime Minister Johnson and the EU’s Ursula Von Der Leyen. If we end up with an ongoing stand-off that takes negotiations into next year, sterling could continue to suffer in the nearest term. And longer term, as noted above, UK structural concerns persist. Technically, the pair doesn’t start to breakdown until trading below perhaps 1.3000, and “the right” development can certainly change the near-term momentum just as violently back the other way. Expressing a view through options is a way to avoid headline risk.