Fed to calm markets with 'dovish hike', Santa rally to continue?

The Day So Far

All eyes on the FOMC meeting today as Yellen & Co. get another opportunity to kick-start their much- discussed hiking cycle with a 0.25% rise later today. We’ve been here before of course, as recently as September, when the Fed shocked markets by backing away at the last minute, although we concur with the Fed Funds Futures which are pricing in an 80% chance of a rate rise today. Judging by the reaction of markets this morning, with equities grinding higher as we enter the meat of the ‘Santa rally’, a dovish hike is largely priced in and much of the focus will be on the ‘dot-plot’ i.e; the trajectory of where FOMC members see interest rates in the coming years. The dollar has continued to trade on the front foot against sterling in particular with cable testing the 1.50 handle this morning, although some of this could be attributed to a dovish article written in the FT today by BoE Governor Carney.

The raft of PMI data out of Europe generally came in ahead of expectations, which has capped the follow- through to the downside in EUR/USD following yesterday’s heavy move lower. We expect the dollar to continue to strengthen as we come closer to ‘zero hour’ this evening.

The API crude inventories last night showed a build of 2.3 million barrels, bringing last week’s surprise drawdown to an abrupt end. The US congress also yesterday agreed to lift the ban on crude exports for the first time since the 1970s, potentially paving the way for a flood of shale oil into the international markets. Do not expect an immediate bearish reaction to this news, as the US remains a net importer of crude and will continue to be one for the foreseeable future. Of more significance in terms of its impact on global supply will be the eventual loosening of the sanctions on Iran next year. For now though, expect prices to oscillate between the 2009 lows and $40 a barrel level.

The Afternoon View

Understandably, much of today’s focus will be in the Fed later but before then we are going with the prevailing trend of equity and dollar strength. The ‘Santa’ rally looks to be arriving on cue and we expect a little more upside through to Christmas as the Fed calms markets with a ‘dovish’ hike. For crude we recommend a short from yesterday's highs, also R1 for today, while we look for t-notes to continue to come under pressure as US treasury longs exit their positions before what is expected to be the first Fed rate hike since August 2006. Please note that we do not recommend holding these trades over the FOMC announcement and subsequent press conference this evening.

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