The USD saw a boost from Thursday's comments by China's Commerce Ministry that the U.S. and China had agreed to a phased reduction in tariffs. A U.S. official, speaking on condition of anonymity, confirmed that the rollback would be part of the first phase of a trade agreement. However, White House trade adviser Peter Navarro said in an interview on Thursday, "there is no agreement at this time to remove any of the existing tariffs as a condition of the phase one deal," even though White House spokeswoman Stephanie Grisham said the U.S. is "very, very optimistic" about completing a deal. Meanwhile, Michael Pillsbury, an adviser to U.S. President Donald Trump, said: "There is no specific agreement for a phased rollback of the tariffs. The American side has been ambiguous when and which tariffs will be lifted. The Chinese have some wishful thinking and are trying to soothe their domestic hardliners that the tariffs will someday come off."
The market might be getting ahead of itself here. There is still some doubt whether there will be a tariff reduction as part of a phase one trade deal, and even if tariffs are reduced, the September tariffs were only the latest in a series and will not fully offset the impact of the trade war. Meanwhile, the U.S. money market has now priced out most of the risk of any near-term Fed easing, with only a 5% chance seen in December, around a 35% chance by the end of Q1 and a 62% chance by the end of Q2 2020. This is despite forward-looking indicators and Fed rhetoric suggesting that risks are to the downside for rates.
For FX, the USD boost from trade optimism has been most significant in USD/JPY, which tends to move with yield spreads and equities. Rising U.S. yields and equities have both been a boost for the pair, but the rise in JGB yields have reduced the negative implications for JPY to some extent. Our models suggest that the move in USD/JPY is a little overdone here given the equity and yield moves that we have seen. Additionally, 109.37 represents a significant Fibonacci retracement level. Given that most of the good news is in the market, USD/JPY strength is a little overdone and the fact that there is major technical resistance, it is hard to see further significant USD gains from here.
For EUR/USD, the story is similar. EUR/JPY continues to correlate closely with the bund/JGB spread, which suggests a level close to 121. If USD/JPY stalls here on the upside, EUR/USD is also likely to stall on the downside, with strong technical support seen near 1.10.