Summary: US equities ended last week on a strong note despite the US November CPI registering its highest levels in decades, perhaps as the market slightly lowered Fed rate hike expectations for next year in the wake of the data. This week, the focus turns to the US FOMC meeting on Wednesday, as the Fed will likely significantly update the monetary policy statement and guidance after the recent notable hawkish shift in its intent to fight inflationary pressures.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - S&P 500 futures reached a new closing all-time high on Friday despite the US inflation report showed the highest level of inflation in more than four decades, underscoring that a large part of market participants is still believing in the transitory inflation story. S&P 500 futures are trading around the 4,715 level this morning in early European trading with the 4,700 being the key support level. Nasdaq 100 futures are still suffering from their recent drawdown trading around the 16,370 level with the 16,442 level as the key resistance level in today’s session should risk-on sentiment continue.
EURUSD – Friday’s action underlined the EURUSD sensitivity to Fed expectations, as these fell a few basis points for next year despite the very hot US November CPI numbers, perhaps as the market was slightly relieved that inflation was not higher still. If the Fed waxes more hawkish than anticipated at this Wednesday’s meeting, could see new highs in Fed rate expectations that driver EURUSD to new lows below the November low just south of 1.1200. The ECB also meets and would need to surprise to the hawkish side to change the narrative that this pair is merely tracking the EU-US yield spread at the short end of the curve.
USDCNH – last week, China sent a significant signal suggesting that it would prefer to brake the well established and broad strengthening trend in the renminbi (or yuan) just after USDCNY and the offshore USDCNH crossed to new lows for 2021 below the 6.35 area. A regulator on Thursday announced new FX reserve requirements for banks and then the daily “fix” was set at a weaker level than expected. After a long run higher this year and especially over the last couple of months, the renminbi exchange rate versus an officially defined basket of currencies had reached new highs since the very week it was defined back in late 2015. The CNH is likely to mean revert at minimum after this signal, trading weaker not only versus the US dollar, but also against the official basket.
Crude oil (OILUKFEB22 & OILUSJAN22) trades near a three-week high as the market continues to view current omicron worries as short term concerns and mounting speculation that China, the world’s biggest buyer of crude oil, will start adding fiscal stimulus in early 2022 in order to stabilise the economy. Both Brent and WTI are challenging their 21-day moving averages with a break above potentially adding more technical momentum. Speculators meanwhile reduced Brent crude oil longs in the week to December 9 for a ninth, and nine weeks of non-stop reductions have seen the net long drop to a 13-month low. A behavior which is in stark contrast to the overall market belief in higher prices into 2022. Focus turning to monthly oil market reports from OPEC today and IEA tomorrow.
Gold (XAUUSD) remains stuck below its 200-day moving average at $1794 with focus this week on Wednesday’s FOMC meeting, and how they will respond to inflation rising at the fastest pace since the 1980’s. The market is currently pricing in three rate hikes next year with the first one due around June. Countering the negative price impact of a potential more aggressive US central bank, the rapid spreading of the omicron virus is also receiving some attention given its potential negative growth impact.
US Treasuries (TLH, TLT). This week the spotlight will be on Wednesday’s FOMC meeting. The market expects the Federal Reserve to accelerate the pace of tapering as central bank members grow more anxious about inflation. Yet, it will be unlikely to see Powell particularly hawkish amid a new wave of Covid. Therefore, the yield curve could steepen slightly with long-term yields rising. However, there is only that much where long-term yields can go, as omicron distortions will continue to compress them. Thus, it looks likely that 10-year yields will continue to trade rangebound until the end of the year.
European sovereign bonds (IS0L, BTP10). The ECB will also need to deliver its monetary policy decision before Christmas. An announcement of the end of the PEPP program in March 2022 is widely anticipated as the central bank has mentioned its end throughout the second half of the year. What is not clear is whether an announcement of the increase or modification of the APP program will be communicated this week. It is likely that the ECB will stall as members are torn between inflation and a new wave of Covid infections. As investors feel the support of the central bank is fading, European yields might resume their rise with the periphery and Italian BTPS leading the way.
UK Gilts (IGLT, IGLS). The BOE might not deliver on a 10bps interest rate hike this week as members are divided concerning Covid restrictions. Michael Saunders, one of the most hawkish MPC members, said that he will need to think about it twice before voting for a rate hike. As expectations for interest rate hikes in the UK are the most aggressive among developed economies. It is possible that if the central bank does not hike, the Gilt yield curve will be steeping with short-term Gilts gaining the most as the market pushes back on next year’s rate expectations.
What is going on?
US November CPI recap: in-line with expectations for multi-decade highs. The US November CPI data, released Friday ,was out at +6.8% year-on-year for the headline and +4.9% for the ex Food and Energy number, both as expected. The month-on-month data was +0.8%/0.5% vs. +0.7/+0.5% expected
G-7 foreign ministers warn Russia on Ukraine, suggesting “massive consequences” await the country on any invasion of Ukraine. US Secretary of State Blinken has suggested that the Nord Stream 2 pipeline can be used as leverage in dealing with Russia, but that leverage goes both ways as many believe Russia has reduced natural gas supplies purposefully to speed the opening of the pipeline an ease the enormous spike in gas prices since October. Germany’s Chancellor Scholz has not spoken recently on the issue.
The weekly Commitment of Traders report showed that speculators have turned their attention towards reducing positions. December is normally a time of year when traders reduce exposure as liquidity starts to dry up as trading books are being reduced ahead of the holidays and yearend. The net changes may therefore not give many insights with regards to the short-term direction of the market. In the latest reporting week to December 7 commodities saw broad net selling despite broad price gains while in forex the dollar long against ten IMM currency futures was reduced by 16% despite a stronger greenback.
Industrial metals have started the week on a firm footing with iron ore jumping 6% on raised expectations that China will move to increase stimulus next year to support the economy. Following the end of a three-day annual Central Economic Work Conference, the party signaled a clear change in focus away from growth towards ensuring stability. They also vowed to front load policies to halt the recent slide.
Lack of breadth in equities. Looking across our Saxo equity theme baskets our Mega Caps theme which consists of the largest companies in the world is up 37% this year being the third best performing theme. This shows how much the largest companies have pulled this year in terms of performance, but it also shows the lack of breadth in the equity market and thus the equity indices might be sending the wrong signals in terms of forward-looking assessment of the economy.
What are we watching next?
A very busy week ahead for major central banks this week, with Fed, ECB and BoE all in focus. The US Federal Reserve’s FOMC meeting is up on Wednesday, with a very different new monetary policy statement expected after the Fed’s clear pivot to inflation fighting mode, while the economic forecasts and especially Fed policy forecasts will indicate how much the Fed now agrees with market forecasts for approximately three rate hikes next year, after prior forecasts have come in well below market expectations. The ECB meets Thursday and will provide its latest economic forecasts and its plans for asset purchases beyond the end of its emergency QE programme established in the wake of the covid pandemic outbreak. The Bank of England also meets Thursday as the market was confused by prior signaling on interest rate hikes and is unsure whether the bank hikes this week, now seen as very unlikely due to ongoing high virus numbers and the new omicron variant, though a hike is still expected at the February BoE meeting.
UK politics this week as PM Johnson in trouble on having held a Christmas party that flouted lockdown rules last year. Weekend polls suggest a Labour lead, one showing the largest lead in years. A local election this Thursday could result in a challenge of Johnson’s party leadership if the Liberal Democrats win.
The European Council meets on December 16, and apart from having to deal with Covid-19 and the Russian threat on its eastern borders, the council is also set to decide whether investments in gas and nuclear energy should be labelled climate friendly. The design of the EU green investment classification system is closely watched by investors worldwide and could potentially attract billions of euros in private finance to help the green transition, especially given the need to reduce the usage of coal, the biggest polluter.
Earnings Watch – the earnings calendar is getting very this week.
Thursday: FedEx, Adobe, Accenture
Friday: Capitaland, Darden Restaurants
Economic calendar highlights for today (times GMT)
0900 – Switzerland Weekly Sight Deposits
1130 – ECB's Centeno to speak
1500 – Canada Bank of Canada to announce mandate renewal
1600 – Canada Bank of Canada Governor Macklem press conference
1700 – UK Bank of England financial stability report, stress test results
1730 – UK Bank of England press conference
0030 – Australia Nov. NAB Business Conditions/Confidence
During the day: OPEC’s Monthly Oil Market Report
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2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
