GBP

Negative headlines from the UK-EU negotiations drove sterling sharply down last week. However, over the weekend Boris Johnson and Ursula Von der Leyden agreed to extend Sunday’s deadline. Officials involved in the negotiations hinted that a deal is close, though the pound only recovered about half the losses of the last week on those positive news.

Differences remain on the key issue of a level playing field to ensure that the UK doesn’t weaken its environmental and labour standards to outcompete the EU. If there is an agreement there, we think that the other remaining roadblock, fishing rights, is very unlikely to bring about the collapse of the negotiations. Therefore, we expect a deal to be reached shortly and the pound should continue to trade with a generally positive tone into year end.

EUR

While the Brexit agreement still hangs in the balance, the EU successfully overcame Hungarian and Polish objections to the rule of law conditions on the Budget and the Recovery Fund. FX markets regarded the ECB December meeting as a bit of a non-event. While the expansion of the pandemic programmes and the operations to support the banks was expected, we think that Lagarde voicing concerns over the strength of the euro and its effect of inflation was more meaningful than the markets acknowledged.

This week is shaping up to be a critical one, with the release of both the PMIs economic activity and the December inflation data. In the short-term, the common currency could be vulnerable to a disappointment in either of these, particularly given the sharp recent rally and the stretched long euro positioning in the market.

USD

The US dollar appears to have stabilised for now, after falling for six straight months in trade-weighted terms. Paradoxically, this comes as the economic newsflow out of the US turns negative, with yet another negative surprise in the weekly jobless claims last week.

We now turn to the last Federal Reserve meeting of the year. No changes in monetary policy are expected, and the focus is again on the FOMC economic projections, the expected path of monetary policy summarized in the “dot plot”, and the tone of communications from Chair Powell at the press conference after the meeting. Less predictable is the outcome on talks for a fresh fiscal stimulus package, which we still expect to lead to agreement given the weaker narrative emerging from economic data over the past few weeks.

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