FX Update: Brexit crunch time, and what are last hurdles for USD bears?

Forex 6 minutes to read
John Hardy

Head of FX Strategy, Saxo Bank Group

Summary:  Strong risk sentiment continues and a fresh surge in industrial metals has helped AUDUSD to new highs. But our focus should be squarely on sterling today and in coming days as Brexit crunch time has arrived and disaster insurance buying has picked up on the latest uncertainty. Elsewhere, we look at the last remaining hurdles for USD bears heading into year-end.


Today’s FX Trading focus:

Brexit crunch time is here
UK Prime Minister Boris Johnson is set to meet with EU commission head Ursula Von Der Leyen this evening for dinner in Brussels in an effort to move forward the stuck Brexit negotiations. The critical outstanding issue is the “level playing field” or “state aid” issue. While we have assumed all along that some sort of a deal would inevitably be hashed out between the two side, even if it was a rather thin deal that disguises the need for ongoing negotiations on particulars based on a loose framework of principles. But the latest turn in negotiations has raised the fear of a proper stand-off that brings with it a cliff-edge risk into year end. I still suspect some sort of fudge, or at worst, delay is more likely than a cliff edge, but we should all respect the uncertainty of the situation.

The market is certainly respecting the uncertainty more than is shown in the choppy action in the spot GBP exchange rates, as GBPUSD 1-month implied volatility has pulled higher toward 13% and the 10-delta options are 5.5% more expensive for puts than calls – getting close to where  they were during the pandemic meltdown, for perspective. As soon as in the wake  ofthis evening’s meeting between Johnson and Von Der Leyen we should have a headline indicating the latest temperature of the situation and whether we are moving in the “right” direction or toward a nail-biting stand-off.

Elsewhere – USD weak but requires extension of speculative froth for more downside
As we pointed out in this morning’s Saxo Market Call podcast, some measures of risk sentiment are nearing remarkable extremes, after November was the most positive month in global market history. Many have pointed out that the very strongest runs of risk appetite often yield to even more upside statistically, so far be it from us to call the end to this remarkable run for global markets, but the USD lower argument seems entirely bound up in soaring risk sentiment and it may be a reflexive trade.

On that note, perhaps only three readily identifiable risk events can spoil the party ahead of the end of the year.

  • The first would be any lack of a stimulus deal – and that situation has gotten more than a bit chaotic with the White House now weighing in and proposing checks for everyone rather than the unemployment benefit extension proposal, but it does appear the sides are working toward a deal and I don’t rate the danger level high on this one.
  • The second would be the FOMC meeting next Wednesday and whether the Fed is somehow set to either deliver less than the market is expecting and very gently press back against the speculative exuberance. I don’t think they dare do the latter, though they might under-deliver in terms of a forward commitment to easing and here I rate the danger level at medium to unknown in terms of whether the market really fears that the Fed will deliver in a pinch anyway.
  • Finally, and this is where the danger level is highest, we have the US yield curve and whether yields finally blow out higher, starting with a move above 1.00% in the US 10-year benchmark. Yesterday’s 3-year Treasury auction was weak and we have 10-year and 30-year auctions up today and tomorrow, respectively.

After the end of the  year, the Georgia Senate runoffs are an additional wildcard on January 5 – more on that later.

Chart: AUDUSD
AUDUSD is enjoying a fresh surge as risk appetite remains robust and industrial metals have been on quite a ride higher in recent sessions, particularly the Aussie- important iron ore. AUDUSD is now well free of the 0.74000 area, with no real notable resistance until the 0.80-0.8100 zone that capped the action back in early 2018.

Source: Bloomberg

The G-10 rundown

USD – the flipside of the global surge in risk assets.

EUR – the euro may be held back a bit by its negative yielding status and the wait for stimulus as well as the ECB set to deliver new easing tomorrow, but don’t see the latter as a major event risk with so much already priced in.

JPY – the yen more or less tracking the USD in the crosses here and likely to continue to do so unless risk sentiment sours badly, which would be JPY supportive unless the source of angst is rising US yields, in which case you have confusing crossfire.

GBP – very short term calls are one way to position for a breakthrough in the Brexit logjam – plenty of binary risk at any point starting from any statements made after this evening’s Brexit dinner in Brussels.

CHF – Is EURCHF fearing a more aggressive ECB? Doubt that the latter is much of a catalyst here and suspect that global bond yields are more important, with rising yields potentially pushing back against CHF strength.

AUD – the go-to currency if the current environment extends, especially metals prices.

CAD – Bank of Canada meeting later today – not expecting anything there. CAD could be set for a run for 1.2500 quickly on another surge higher in crude oil prices together with a strong run in risk assets into year end – the caveats are listed in the USD commentary above.

NZD – the kiwi at risk of relative weakness in the crosses if commodities continue to grab the headlines – thinking especially of AUDNZD here, where another surge toward 1.0600 would begin to disrupt the late downtrend.

SEK – the krona has taken a turn for the worse in not responding to what normally have been supportive conditions – seasonal pension flows might be a driver and we like fading SEK weakness against the euro eventually, with the caveat that 10.30 falling in EURSEK could see a bit more of a squeeze.

NOK – a real breakdown in EURNOK below 10.50 may require a new leg higher in Brent above 50 dollars/ barrel.

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