The Week Ahead: Will Thursday’s rendezvous’ stop EURphoria?

We have another blockbuster week to close in on the end of the year of all years. When you cover so many risk events and try and decipher what drivers are significant and which catalysts will peter out, the interminable list of meetings, talks and negotiations sometimes appears to come across as white noise. But we are finally coming to the endgame for some issues which have been going on for months and years.

On the political front, Brexit takes centre stage. Following the newswires has been no help at all recently, as the two competing sides continue to jostle for the upper hand to sell to their respective audiences. Last-push negotiations have resumed in Brussels over the weekend but are being hampered by disagreements over keeping a ‘level playing field’. The jury is out as to whether there is any light at the end of the ‘tunnel’ and if there is a ‘landing zone’ for an agreement to take to Thursday’s EU Council meeting. This is supposed to be the critical date for any deal on future arrangements to be given the green light by EU leaders. 

Many observers are now veering towards a no deal but potentially with a last-minute extension for the transition period with a framework for further negotiations. If that sounds like a hedge for most eventualities, then perhaps we have finally come to the brink where we do actually get a deal. A ‘skinny’ deal is favoured here as there is too much at stake not to agree on something. That the focus will be on trade rather than services will still leave huge uncertainty for most UK business. 

Cable has been volatile, as one would expect over the last week, first falling to the 1.33 area before recovering sharply to 1.35. Options markets have shown a growing premium for downside protection over the last few days, so it seems traders are happy to ride the dollar weakness and hold spot but protect via optionality. 

The EU council meeting will be important not just for Brexit, but also the region’s Recovery Fund which is meant to be the latest grand project and symbol of European unity. Leaders will try and reach a compromise on the key issue of fiscal support both for the NextGeneration pandemic package and the multi-year budget. But given Hungary and Poland’s veto in November, talks may prove tricky which means a delay to critical stimulus in 2021.

Thursday will also see the final ECB meeting of the year and a potentially big one for the single currency. While President Lagarde has given clear signals that more easing is coming, in the form of a ‘recalibration’ of existing tools, it would be a very dovish surprise if the deposit rate is lowered further into negative territory. An extension to the QE programmes and liquidity operations is expected, as Lagarde seeks to leave any bazooka in the box. 

With the Euro climbing more than 8% against the dollar this year, and crucially breaking through ‘the line in the sand’ (1.20 in EUR/USD) will the ECB try to slow the ascent? Notably, the trade-weighted euro has not strengthened as much and it is global factors and a weak dollar that have driven down the world’s most popular currency pair. Instead, it is governments in the bloc who need to step up and do some heavy lifting.