diff --git a/src/vs/workbench/services/configuration/browser/configuration.ts b/src/vs/workbench/services/configuration/browser/configuration.ts
index c3c02c415d86bffeb5f4d3baaebee31aa9e60aa8..b50b68adfb9a718448c80fd573a645250f689e3e 100644
--- a/src/vs/workbench/services/configuration/browser/configuration.ts
+++ b/src/vs/workbench/services/configuration/browser/configuration.ts
@@ -59,7 +59,7 @@ export class UserConfiguration extends Disposable {
 		const fileServiceBasedConfiguration = new FileServiceBasedConfiguration(folder.toString(), [this.userSettingsResource], standAloneConfigurationResources, this.scopes, this.fileService);
 		const configurationModel = await fileServiceBasedConfiguration.loadConfiguration();
 		this.userConfiguration.value = fileServiceBasedConfiguration;
-		this._register(this.userConfiguration.value.onDidChange(() => this.reloadConfigurationScheduler.schedule()));
+		this._register(fileServiceBasedConfiguration.onDidChange(() => this.reloadConfigurationScheduler.schedule()));
 		return configurationModel;
 	}
 
@@ -108,7 +108,7 @@ class FileServiceBasedConfiguration extends Disposable {
 						errors.onUnexpectedError(error);
 					}
 				}
-				return undefined;
+				return '{}';
 			}));
 		};
 
@@ -723,6 +723,7 @@ export class FolderConfiguration extends Disposable implements IFolderConfigurat
 		this.folderConfiguration = this.cachedFolderConfiguration = new CachedFolderConfiguration(workspaceFolder.uri, configFolderRelativePath, configurationCache);
 		if (workspaceFolder.uri.scheme === Schemas.file) {
 			this.folderConfiguration = this.createFileServiceBasedConfiguration(fileService);
+			this.folderConfigurationDisposable = this._register(this.folderConfiguration.onDidChange(e => this.onDidFolderConfigurationChange()));
 		} else {
 			whenProviderRegistered(workspaceFolder.uri, fileService)
 				.then(() => {
@@ -733,7 +734,6 @@ export class FolderConfiguration extends Disposable implements IFolderConfigurat
 					this.onDidFolderConfigurationChange();
 				});
 		}
-		this.folderConfigurationDisposable = this._register(this.folderConfiguration.onDidChange(e => this.onDidFolderConfigurationChange()));
 	}
 
 	loadConfiguration(): Promise<ConfigurationModel> {
diff --git a/src/vs/workbench/services/configuration/test/electron-browser/configurationService.test.ts b/src/vs/workbench/services/configuration/test/electron-browser/configurationService.test.ts
index 45de7c07ca163ba5313b64bd4de6cc815a0b5295..87c8c7d839a0b7586766a72501fcb12da4d3ab86 100644
--- a/src/vs/workbench/services/configuration/test/electron-browser/configurationService.test.ts
+++ b/src/vs/workbench/services/configuration/test/electron-browser/configurationService.test.ts
@@ -30,7 +30,7 @@ import { IJSONEditingService } from 'vs/workbench/services/configuration/common/
 import { JSONEditingService } from 'vs/workbench/services/configuration/common/jsonEditingService';
 import { createHash } from 'crypto';
 import { Schemas } from 'vs/base/common/network';
-import { originalFSPath } from 'vs/base/common/resources';
+import { originalFSPath, joinPath } from 'vs/base/common/resources';
 import { isLinux } from 'vs/base/common/platform';
 import { RemoteAgentService } from 'vs/workbench/services/remote/electron-browser/remoteAgentServiceImpl';
 import { RemoteAuthorityResolverService } from 'vs/platform/remote/electron-browser/remoteAuthorityResolverService';
@@ -47,6 +47,7 @@ import { IKeybindingEditingService, KeybindingsEditingService } from 'vs/workben
 import { NativeWorkbenchEnvironmentService } from 'vs/workbench/services/environment/electron-browser/environmentService';
 import { IWorkbenchEnvironmentService } from 'vs/workbench/services/environment/common/environmentService';
 import { timeout } from 'vs/base/common/async';
+import { VSBuffer } from 'vs/base/common/buffer';
 
 class TestEnvironmentService extends NativeWorkbenchEnvironmentService {
 
@@ -719,6 +720,7 @@ suite('WorkspaceConfigurationService - Folder', () => {
 
 	let workspaceName = `testWorkspace${uuid.generateUuid()}`, parentResource: string, workspaceDir: string, testObject: IConfigurationService, globalSettingsFile: string, globalTasksFile: string, workspaceService: WorkspaceService;
 	const configurationRegistry = Registry.as<IConfigurationRegistry>(ConfigurationExtensions.Configuration);
+	let fileService: IFileService;
 
 	suiteSetup(() => {
 		configurationRegistry.registerConfiguration({
@@ -767,7 +769,7 @@ suite('WorkspaceConfigurationService - Folder', () => {
 				const environmentService = new TestEnvironmentService(URI.file(parentDir));
 				const remoteAgentService = instantiationService.createInstance(RemoteAgentService, {});
 				instantiationService.stub(IRemoteAgentService, remoteAgentService);
-				const fileService = new FileService(new NullLogService());
+				fileService = new FileService(new NullLogService());
 				const diskFileSystemProvider = new DiskFileSystemProvider(new NullLogService());
 				fileService.registerProvider(Schemas.file, diskFileSystemProvider);
 				fileService.registerProvider(Schemas.userData, new FileUserDataProvider(environmentService.appSettingsHome, environmentService.backupHome, diskFileSystemProvider, environmentService));
@@ -776,6 +778,9 @@ suite('WorkspaceConfigurationService - Folder', () => {
 				instantiationService.stub(IConfigurationService, workspaceService);
 				instantiationService.stub(IEnvironmentService, environmentService);
 
+				// Watch workspace configuration directory
+				fileService.watch(joinPath(URI.file(workspaceDir), '.vscode'));
+
 				return workspaceService.initialize(convertToWorkspacePayload(URI.file(folderDir))).then(() => {
 					instantiationService.stub(IFileService, fileService);
 					instantiationService.stub(IKeybindingEditingService, instantiationService.createInstance(KeybindingsEditingService));
@@ -1101,6 +1106,37 @@ suite('WorkspaceConfigurationService - Folder', () => {
 		fs.writeFileSync(globalTasksFile, '{ "version": "1.0.0", "tasks": [{ "taskName": "myTask" }');
 		return new Promise((c) => testObject.onDidChangeConfiguration(() => c()));
 	});
+
+	test('creating workspace settings', async () => {
+		fs.writeFileSync(globalSettingsFile, '{ "configurationService.folder.testSetting": "userValue" }');
+		await testObject.reloadConfiguration();
+		const workspaceSettingsResource = URI.file(path.join(workspaceDir, '.vscode', 'settings.json'));
+		await new Promise(async (c) => {
+			const disposable = testObject.onDidChangeConfiguration(e => {
+				assert.ok(e.affectsConfiguration('configurationService.folder.testSetting'));
+				assert.equal(testObject.getValue('configurationService.folder.testSetting'), 'workspaceValue');
+				disposable.dispose();
+				c();
+			});
+			await fileService.writeFile(workspaceSettingsResource, VSBuffer.fromString('{ "configurationService.folder.testSetting": "workspaceValue" }'));
+		});
+	});
+
+	test('deleting workspace settings', async () => {
+		fs.writeFileSync(globalSettingsFile, '{ "configurationService.folder.testSetting": "userValue" }');
+		const workspaceSettingsResource = URI.file(path.join(workspaceDir, '.vscode', 'settings.json'));
+		await fileService.writeFile(workspaceSettingsResource, VSBuffer.fromString('{ "configurationService.folder.testSetting": "workspaceValue" }'));
+		await testObject.reloadConfiguration();
+		await new Promise(async (c) => {
+			const disposable = testObject.onDidChangeConfiguration(e => {
+				assert.ok(e.affectsConfiguration('configurationService.folder.testSetting'));
+				assert.equal(testObject.getValue('configurationService.folder.testSetting'), 'userValue');
+				disposable.dispose();
+				c();
+			});
+			await fileService.del(workspaceSettingsResource);
+		});
+	});
 });
 
 suite('WorkspaceConfigurationService-Multiroot', () => {