Santa Claus rally in 2022 at risk, as market uncertainty grows near December FOMC
The last month of the year is considered to be bullish for financial markets. Assets like stocks and crypto tend to go up, the US Dollar weakens against currencies like the Euro or Sterling, and there is little volatility in interest rates.
Although this trend was noted quite a few times in the past, when it comes to 2022, there are still some uncertainty drivers that might dampen the prospects for positive sentiment around Christmas. The most important one is the December meeting of the Federal Reserve, during which markets might again be surprised with a more aggressive reaction function.
Financial markets pricing in hawkish FED
Markets started this week on the back foot as investors continue to show concern about how economic data is going to impact the FED’s decision. True, interest rates are expected to rise by 50 basis points, but the focus remains on the terminal rate and how much the central bank wants to keep rates at higher levels.
At the December meeting, an updated dot plot and SEP will be released, which is an incentive for traders and investors to buy some protection ahead of time. Implied volatility is trading below realized volatility, suggesting that market participants are not well hedged in the face of an event that can provide a lot of surprises.
According to easymarkets.com, a popular CFD broker, this year has been about the FED and monetary policy changes. Considering economic activity, job creation, and wage increases remain strong, there is no reason to shift away from a tightening cycle in the short term.
US economic activity still too strong
The latest economic data came above expectations and markets treated that as negative, since the FED has reason to be more hawkish. The latest NFP report showed 263,000 jobs have been added in November.
Moreover, a real surprise came in the form of wage increases, which averaged +0.6% last month and 5.1% for the entire year. These figures are not consistent with the 2% inflation mandate that the FED is abiding by, and suggest that the December meeting might see the terminal rate going higher. Estimates are ranging between 5%-7%, with a growing division among FOMC members, due to fears of overtightening.
Relief to follow after the FED meeting?
On December 14th, 2022, the FED will publish its decisions and its chair Jerome Powell will hold a press conference as usual. In the absence of a major negative surprise, financial markets will probably be under pressure until the news is out, only to start edging up in a relief rally afterward.
There is still no solid reason to hold stocks or crypto in the long run, but at the same time, traders are not inclined to go into the Christmas holiday with short positions open. Volatility is low around holidays and markets might wait until 2023 to start trending lower. However, this script depends on what happens next week, given FED policy decisions have global implications.