The biggest driver of currency flows this week are US / China trade headlines. Early on the outlook was grim with talk of the phase one trade deal delayed to December. However sentiment shifted dramatically overnight after China's Ministry said they agreed to lift tariffs as the deal progresses. Both countries want a Phase 1 deal on paper by the end of the week and the US confirmed that tariff rollbacks are possible. There's opposition in the US government but the mere possibility that the tariffs could be lifted sent currencies and equities sharply higher. The Dow Jones Average rose to its strongest level ever while USD/JPY hit a 5-month high. There are still some conflicting headlines including US Senior Economic Advisor Larry Kudlow's comment that there will be tough concessions if a phase 1 deal is completed. As our colleague Boris Schlossberg noted this morning, the "US-China trade story has had almost as many ups and downs as the Brexit battle," but for now the latest headlines suggest progress towards a meaningful agreement, which is enough to boost risk appetite. However the restrained rally in the Australian and New Zealand dollars also reflect the market's cautiousness in this headline driven market. Barring any fresh news that could cast doubt on progress towards a deal, USD/JPY could extend its gains to 110.

Sterling on the other hand dropped to a 2 week low. The Bank of England voted 7-2 to leave interest rates unchanged. While we wrote about a possible division in yesterday's BoE preview, the split caught the market by surprise. Michael Saunders and Jonathan Haskel voted in favor of an immediate 25bp rate cut. They are worried about the weakness in the labor market and the threats that global growth and Brexit uncertainty poses to the economic outlook. The central bank also lowered their 2020 and 2021 GDP forecast and their near term inflation forecasts which are all based on one rate cut over the next 3 years. According to Governor Carney, the global picture has darkened, Brexit uncertainty has hit UK investment and the UK-EU deal could change the investment picture. Right now UK underlying growth has slowed below potential and there is evidence that consumers are becoming more cautious. All of this means that the risks to UK growth are skewed to the downside and if the risks materialize, the economy may need reinforcement. So despite a withdrawal agreement, sterling could suffer from the central bank's cautiously dovish outlook. We've long said that a Brexit deal provides only near term relief for the currency and the economy because it won't be long before the true cost of Brexit is revealed.

Euro dropped to a 3 week low on the back of softer German industrial production and a weaker EU growth forecasts. The European Commission cut its GDP forecast for the region, citing global trade tensions and their view that growth is no longer expected to rebound meaningfully in the next 2 years. The Commission feels that "the surge in trade tensions and record-high uncertainty about trade policy is likely to have inflicted lasting damage to world trade." Although the ECB's economic bulletin was more upbeat with the central bank looking for modest but positive growth in the second half investors kept the pressure on euro.

The Canadian dollar will be in focus tomorrow with labor market numbers scheduled for release. Given the Bank of Canada's somber mood and the sharp drop in the employment component of IVEY, we expect tomorrow's report to show a meaningful slowdown in job growth. USD/CAD has yet to break 1.32 but the employment report could do the trick.

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