Sentiment remains positive for risk in the run to the year end

Macro Outlook

If she has not done so in previous FOMC press conferences, Janet Yellen came across as a very solid and certain chairman. She portrayed a calm and steady hand on the tiller. This was just what markets needed. Criticism has been laid at the door of the Federal Open Market Committee for making statements overly long and complicated in recent years, however Yellen’s press conference explained concisely that the Fed does not intend to raise interest rates for at least the next two meetings. I see this as having no real impact on the actual timing of a rate hike. The market has for a while been pricing in a mid to late summer rate hike, depending upon whether you look at Euro/Dollar futures (before September) or the Fed Funds futures (October/November time). However, this has removed the uncertainty of an early rate hike and suggests that the Fed will remain loose on monetary policy for probably at least the next six months. Cue a dramatic rise in appetite for risk. The market apparently still remains at the behest of the Fed and for now Janet Yellen has opened the way for a renewed period of gains on the equity markets and likely continuation of the dollar strength. All the while the US economic recovery continues and this is the biggest positive to highlight as we move into the new year.

Must watch for: US Q3 GDP (final reading)

Impact: Previous readings of US Q3 GDP have both beaten consensus expectations and with a final figure expected to show another upward revision the impact should be dollar positive. The increase from the advance reading of 3.5% shows how the US economy in Q3 continually looks ever more rosy and adds weight to the argument for the FOMC hawks. The markets are expecting another strong number and with this in mind perhaps the only real risk would be a negative surprise. However, on a week of tying up loose ends, the market should take the release in its stride.

Foreign Exchange

There are different takes on why the dollar has rallied in the past few days. My analysis suggests that a flight away from Treasuries pushes up longer term interest rates which improves demand for the dollar. Also there has been an element of short covering on the short Dollar/Yen positions. This has all driven a sharp rally on the dollar once more which has put pressure back on the forex majors that had been stoically resisting the selling pressure in recent weeks (i.e. euro and sterling). On Friday, the Dollar Index (.DXY) broke out to multi-year highs again on Friday which helped to drive the euro down to a new two year low. Also the rally on Dollar/Yen has now aborted the corrective top pattern on a move above 119.55. It should only be a matter of time now before Cable follows suit and breaches the recent range low at $1.5540 to move to its own 16 month low.

WATCH FOR: With a light calendar this week due to the Christmas holidays, sentiment is likely to remain positive behind the dollar strength. The data releases that are on are mostly US based and are mostly releases which have been positive in recent months (such as GDP, new home sales and Michigan sentiment). Perhaps the big risk to dollar strength will be the volatile durable goods orders.

Indices

Are we finally about to see a Santa Claus Rally? Every year the debate rages over whether there will be a strong run in equities into the end of December and for a significant proportion of years it turns out to be true. This year though the phenomena has been questioned more that usual, with investor sentiment plummeting amid a precipitous decline in the oil price. However, with support coming in for oil and a supportive Federal Reserve (Janet Yellen suggesting that the FOMC will not raise rates in the next two meetings) the stage is set for a Santa Claus rally. Last week ended with strong gains on equity markets with a surprising lead runner. In recent months as global markets have pushed on to key highs, the FTSE 100 has been a disappointing laggard. One of the chief reasons being a heavy weighting in oil majors (c.15%) and Mining stocks (c. 8%) both of which have rallied significantly since Tuesday’s nadir in sentiment. Conversely, the S&P 500 only has 8% energy plays and 2% in basic materials so has fared less favourably. The DAX is not exposed to oil while mining accounts for just over 11%.

WATCH FOR: If the oil price rallies then the oil majors weighted FTSE 100 could continue to outperform other indices. The general improvement in market sentiment should help to sustain the gains, with little data this week that could really de-rail the rally, conditions are ripe for a Santa Claus rally.

Other Assets: Commodities & Bonds

With Tuesday’s lows on oil still intact it seems as though near term support is building. Oil refinery strikes in Nigeria are possibly drawing towards a close and could add supply back into the market and would be a downward impact on oil, but as yet there is little sign of this coming through yet. With the oil price consolidating, positive US economic data this week could also add to the bull argument and help to drive a rally. Precious metals prices have been choppy recently but the US dollar is beginning to strengthen again and this makes it harder to be bullish on gold and silver once again.

Two factors have driven Treasury yields higher in the past week. The general improvement in risk appetite due to a supported oil price and the reaction to the Fed meeting. The yield on the US 10 year has rallied by almost 10% from a low of 2.01% to around 2.2%. There is also room for this to unwind further back towards the November peak at 2.41%. The continued expectation of disinflation, stagnant growth and potential for QE in the Eurozone is helping to anchor yields on both core and periphery Eurozone yields.

WATCH FOR: There is only a few loose ends to tie up on the US economic data this week and any positive surprises could help support oil, put pressure on precious metals and be positive for US yields.