Deal or No Deal for China? Answer will Set the Course for FX

Investors are nervous that this time, President Trump is serious about raising tariffs on essentially all Chinese goods to 25%. With the Friday deadline looming, President Trump is still keeping the market guessing. In fact just this morning, he said China cannot renegotiate the trade deal but a while later he announced that a "beautiful letter" was sent from President Xi and the two could speak on the phone. This puts the chance of a tariff delay back on the table and according to Trump, a "China deal this week is still possible." USD/JPY which hit a 3 month low in the early NY session when the Dow Jones Industrial Average tumbled more than 400 points, ended the day only slightly lower.

What's interesting about today's moves is that the US dollar sold off alongside stocks. Typically, risk aversion is accompanied by a flight to quality into the greenback but today, investors bailed out of all US assets. Softer producer prices and a higher trade deficit were partly to blame as the slowdown in PPI growth signals weaker consumer price growth on Friday. CPI is the most important piece of US data this week and while economists are looking for price pressures to accelerate due to higher gas prices, the risk is to the downside after PPI. If CPI growth slows, we could see renewed losses in USD/JPY. If they rise 0.4% or more, there will be a cautious relief rally.

But the dollar's reaction will be limited ahead of the Friday midnight tariff deadline.Chances are, the decision to impose or delay the increase in tariffs will come after the market close. Trade talks resumed today and will be followed by a dinner between Chinese Vice Premier Liu, US Treasury Secretary Mnuchin and Trump's top trade negotiator Lighthizer. There's very little time to make a deal but the deadline could be delayed if Trump has a satisfactory conversation with President Xi. Last minute back peddling would not be unusual. Friday will be a high anxiety day as investors wait for Trump's decision and when it is made there will be big potentially sustainable moves in currencies. If the tariffs are hiked, we could see USD/JPY break 109 and AUDUSD hit .68 cents. If they are delayed, expect USDJPY to hit 110.50 and AUDUSD to squeeze above 71 cents.  

Meanwhile keep an eye on USDCAD, which could breakout of its 2 week long consolidation Friday. Labor market numbers are scheduled for release and a disappointing report could send the pair well above 1.35. Although economists are looking for stronger job growth, the Bank of Canada's cautious outlook, the decline in the employment component of IVEY PMI and the softer than expected trade numbers are a sign of weakness in Canada's economy.  Oil prices are falling but there's been limited movement in USD/CAD. The labor market report could be just the trigger for a break that would allow the Canadian dollar to follow other currencies lower.

EUR/USD broke to the upside hitting a high of 1.1250. Unfortunately it is not a convincing break because the pair retreated after Trump suggested that a deal is possible. There's been a lot of two way action in EUR/USD and the downtrend remains intact until we see the pair close firmly above its May high of 1.1265. GBP/USD will also be in play with first quarter GDP numbers scheduled for release. We are looking for stronger numbers because trade and retail sales activity improved in the first 3 months of the year. The pair is stabilizing above 1.30 and could squeeze to 1.31 if the data is good but the sustainability of the move will hinge on risk appetite.