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by Charalambos Pissouros

Risk Appetite Recovers on Trade Talks, Theresa May Delays Brexit Vote

The US dollar recovered on Monday, perhaps due to safe-haven inflows as market sentiment remained fragile during most of the day. However, risk appetite recovered somewhat overnight after China said that it is in talks with the US over trade. The British pound fell sharply yesterday as May decided to delay the Brexit vote in Parliament, despite EU’s signals that the current deal is not negotiable.

USD Attracts Safe Haven Flows, but Appetite Recovers Somewhat Overnight

The dollar traded higher against all but one of the other G10 currencies on Monday. The big loser was GBP, with NOK and CAD taking the second and third place respectively. The only currency that managed to resist the greenback’s strength was CHF.

USD performance G10 currencies

The US dollar staged a comeback after Friday’s lower-than-expected NFPs, perhaps due to a combination of a risk-off mood during most of the day, as well as some stabilization in US Treasury yields, although the 2yr/5yr and 3yr/5yr spreads remained negative. Asian and European markets were a sea of red yesterday after China’s foreign ministry summoned the US Ambassador in protest over the arrest Huawei’s CFO, which may have increased investors’ concerns over fresh tensions between the US and China. US equities ended their session slightly higher, perhaps helped from the recovery in technology stocks.

That said, the fragile risk appetite got a boost overnight following reports that China’s Vice Premier Liu He had phone talks over trade with US Treasury Secretary Steven Mnuchin and US Trade Representative Robert Lighthizer. They discussed a roadmap for future negotiations in order to put into effect what was agreed by the Trump and Jinping in Argentina, according to the reports. Chinese, Australian and New Zealand’s equity indices traded in the green today, but Japan’s Nikkei closed its session in negative territory. The Japanese index may have remained under pressure due to the downside revision in Japan’s GDP for Q3 on Monday. The data showed that the Japanese economy contracted 0.6% qoq in the three months to September, instead of 0.3% as the initial estimated suggested. This could also explain why the yen underperformed the dollar, even as most of the day was marked with subdued appetite.

As for our view, reports of phone calls are fare from suggesting that the dispute is near to be resolved, while Lighthizer’s comments over the weekend keep the door for further escalation open. On Sunday, the US Trade Representative said that the 90-day pause is a “hard deadline” and that more tariffs will be raised if no common ground is found.

GBP Tumbles as May Postpones Parliament Vote

The pound was the main loser as developments surrounding Brexit took center stage once again. It all started with reports saying that UK PM Theresa May will call off Parliament’s Brexit vote that was scheduled for today in order to be able to renegotiate with the EU during the two-day EU summit on Thursday and Friday. However, the European Commission was quick to respond, saying that they will not renegotiate on Brexit. There is already an agreement on the table and this is the best and only one possible, the Commission added.

GBP performance G10 currencies

The British currency came under selling interest as the Commission’s position slashed any hopes that May could bring back to Parliament something better, or at least amendments that could allow MPs to approve the deal. Sterling tumbled even more after May confirmed that she will postpone the vote, saying that the deal would have been rejected by a significant margin. She also confirmed that she will discuss Brexit concerns with EU leaders.

With the EU clearly stating that it will not renegotiate the existing accord, we view all this as kicking the can further down the road. The likelihood for the Parliament to take down the deal, even at a later stage, remains high and thus, the question is still what happens in the aftermath of the vote. Even if EU officials change their mind and appear willing to agree on minor tweaks, there is very little time for May to bring something back on time, and it would still be doubtful whether such tweaks will please UK MPs. The Parliament goes into recess on the 20th of December, which suggests that the vote is more likely to move into 2019.

If MPs decide to take the deal down, it would be hard for them convince the EU in accepting any significant amendments. In order to avoid a disorderly Brexit, they would have to revert Brexit, and with the government clearly saying that it won’t revoke its notice, the options may be a second referendum or a no-confidence vote that could lead to general elections. Having said that though, hardliners within the Parliament may not like the idea of staying within the EU. After all, they reject the existing plan because it keeps the UK closely tied to the EU. Thus, they may prefer to accept May’s accord rather than risk reverting Brexit. Here the question is whether they will manage to outperform those who will seek any scenario that involves no Brexit at all. In our view, all the possible (or not) scenarios discussed within the financial community keep uncertainty over the matter elevated and uncertainty is not something investors like. Therefore, we expect the pound to remain under pressure, at least until the fog clears out.

Moving to other currencies, the Canadian dollar and the Norwegian Krone may have been weighed down by the decline in oil prices. Both WTI and Brent were 2.67% and 2.76% down yesterday, perhaps on concerns over whether the 1.2mn bpd OPEC and its allies agreed to cut is enough to balance supply and demand. The Canadian dollar may have also stayed under selling interest after Canada’s 2yr/5yr yield spread turned negative for the first time since September 2007. Following Canada’s record employment numbers on Friday, which revived expectations with regards to a January hike by the BoC, the inversion of the yield curve may have prompted investors to scale back their bets once again.

GBP/JPY – Technical Outlook

It was not a great start of the week for the British currency yesterday, as the pound sold off due to the Brexit developments. This pushed GBP down against most of its major counterparts. The yen was no exception. GBP/JPY managed to fall around 250 points, if we measure it from the day’s high to its low. Overall, the pair continues to trade below its medium-term upside support line drawn from the low of the 15th of August, and at the same time GBP/JPY is below the short-term downside resistance line taken from the high of the 8th of November. Even if we could see the pair retracing back up, because the momentum is still to downside, we will class such a move as a correction. Hence why we will stick to the downside for now.

If GBP/JPY moves a bit higher, but fails to overcome the 142.80 zone, which acted as a strong support for the pair on the 4th of December and the 26th of October, this might invite the bears again, who would be glad to push GBP/JPY back down. This is when we will target the 142.03 obstacle, a break of which could drag the pair towards yesterday’s low near the 141.15 level. If this time that level is not able to withstand the bear-pressure, a further slide could force GBP/JPY to test the 140.65 area, which was the low of the 20th of August.

In order to start examining the upside again in the near-term, we would need to see GBP/JPY breaking above some of the key resistances. The first one would be the aforementioned short-term downside line, a break of which could place the pair above the 143.70 level, which was the yesterday’s high. This is when the buyers could try and lift GBP/JPY towards the 144.20 obstacle, a break of which might be seen as a good indication that the pair could continue higher. But once again, the upside might be limited due to the previously-mentioned upside support line, which could get tested from underneath and eventually stall the rate.

GBP/JPY 4-hour chart technical analysis

EUR/GBP – Technical Outlook

Even though the euro had a mixed trading session yesterday, it performed well against the British pound. Or should we say that it was the pound that underperformed against its G10 counterparts. Nevertheless, EUR/GBP had a good spur to the upside, where it managed to reach the 0.9087 level, which eventually held the bulls down. Since then, the pair has retraced back down, but this move could be seen as a correction, which may allow the bulls to regroup and take charge again. For now, we will remain positive, at least for the short run.

If EUR/GBP holds above the 0.9030 area, this could be a good sign for the bulls to step in again and drive the pair back up towards the yesterday’s highs at 0.9087. Initially, we could see the pair stalling there, but if the bulls remain in control, EUR/GBP might continue its way north to the next very important area of resistance at the 0.9100 hurdle. This is the highest point of this year.

Alternatively, if the pair drops below the previously mentioned 0.9030 obstacle, then this could lead to a bit more downside. This is when we could aim for the 0.8995 hurdle again, which was the high of the 21st of September. Of course, if the selling momentum remains, then a further rate depreciation might drag the pair towards the short-term upside support line, drawn from the low of the 13th of November, which could limit the downside until the bulls and bears decide who takes the driver’s seat from there.

EUR/GBP 4-hour chart technical analysis

As for Today’s Events

During the European day, we get the UK employment report for October. Expectations are for the unemployment rate to have remained unchanged at 4.1%, while average weekly earnings, both including and excluding bonuses, are anticipated to have grown at the same pace as in September (+3.0% yoy and 3.2% yoy respectively). The case is supported by the IHS Markit/REC Report on Jobs for the month, which noted that starting salaries continued to rise sharply, with the rate of inflation holding close to September’s 41-month record. That said, with the political landscape overshadowing economic releases in the UK, we expect the report to attract less attention that usual and investors to keep their gaze locked on any developments surrounding Brexit.

UK real wages average earnings minus inflation

From Germany, we have the ZEW survey for December. Both the current conditions and economic sentiment indices are expected to have declined to 55.6 and -25.0, from 58.2 and -24.1 respectively.

Later in the day, the US PPIs for November are coming out. The headline PPI rate is forecast to have declined to +2.5% yoy from +2.9%, while the core rate is anticipated to have remained unchanged at +2.6% yoy. This could raise some speculation that the CPIs, due out on Wednesday, may move in a similar fashion.

US CPI vs PPI inflation

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