Oil Treasuries Yellen Just another typical Monday

It looks like populism is well and truly driving financial markets today. First Opec, now non-Opec members have agreed to cut oil production in January, as weak prices for crude send oil producers’ domestic finances into a tailspin. Of course, there hasn’t been an actual cut to production, and as I sit here today the supply and demand fundamentals for the market have not changed. But who cares, the oil price is likely to drift higher, the end of low inflation is upon us, the Treasury market in the US has reacted, and European equities are pondering what this means for future returns.

Although the oil sector is doing well, the FTSE 100 is mildly lower. Overall, though, if the US stock markets can continue to extend recent gains then the FTSE 100 is likely to re-test record highs above 7,100, especially if the steep drop in the pound in 2016 leads to an M&A binge for UK-based companies in the coming months (think Fox and Sky).

But can this bull rally on steroids last?

Sine Trump won the Presidential race the S&P 500 is up more than 8%, while JP Morgan’s share price is 25% higher since Trump won. In the past, the market would be wobbling at the prospect of a Fed rate hiking cycle, but in this environment, stocks are acting like they did 10-15 years ago, and Animal Spirits seem to be driving the markets higher. Trump’s tax cuts, threats to scrap financial market regulation, and his trillion dollar infrastructure investment plans have been enough to drive the Dow and S&P 500 to record highs, led by infrastructure and finance companies, rather than the tech companies, who may have seen their best market performance under Obama. The markets are even willing to overlook an unpredictable President who can turn against a company in the same time it takes to write a tweet. These are interesting times, if the US stock market rally can sustain a hawkish turn from Janet Yellen on Wednesday then irrational exuberance is likely to last well into the New Year.

Typical Monday price action

Treasury yields surged on the back of the oil price move on Monday morning, this also triggered another move higher in USDJPY, which is back at its highest level since February, just below 116.00. If the dollar keeps moving higher then 120.00 is on the cards for USDJPY. EURUSD has backed away from earlier lows, and is now testing 1.06. This seems like typical Monday trading in the FX market: the prevailing trend is taking a backseat. Apart from the yen, the dollar is weaker across the board. We doubt this will last, as we still expect the dollar rally to return, we expect sellers to come into EURUSD around 1.0650, and eventually we could see back to parity at some point in 2017.

Janet Yellen: the most dangerous woman in finance, this week

The focus is firmly on the Fed this week. The market is expecting a 92% chance of a 25bp rate hike this week. There’s only an 8% chance of a 50 bp hike, so Yellen could surprise the market if she opts for a bigger hike. We doubt that she will shock the market, she has formed a habit of delivering what is expected from her. Instead we think she could disrupt expectations for future rate hikes. Right now the market only thinks that there is a 1.4% chance of rates being 2% by end of 2017, there is definitely room for adjustment here if Yellen sounds confident about the outlook and the need to keep a close eye on the monetary punch bowl. This could see rates rise sharply, the dollar surge and it may disrupt the stock market rally. Janet Yellen is the most dangerous woman for stock bulls this week.