The phenomenon of the Santa Rally is typically more associated with the stock market. But it is still relevant to currency traders, because the risk attitude shift. The better performance in equities typically translates into emerging market currencies doing better, and higher volatility. The unusual behavior of markets going through the end of the year, and first couple days of the next, is worth being prepared for.
The Christmas-New Year holiday period is a time when most of the big market movers take some time off. This leaves retail traders with much more influence, and a market running on significantly less liquidity. So, not only can moves be less predictable, they can be bigger. Many traders opt to stay out of the market precisely for that reason. Others might find it an interesting trading opportunity. Either way, often trading strategies that have been honed during regular market hours can have some difficulty around the holidays.
What to Expect
Last week saw most of the global market drop, with the bulk of the blame being laid at the Fed’s feet. The FOMC’s hawkish cut was seen taking the wind out of the market’s sails. But, markets had also been in an upbeat mood through the early part of December, so a correction would be expected. After two days of trading down, markets scored a bit of a recovery late on Friday after US inflation data was softer than expected. That means the rest of the world could play catch up at the start of the week.
With the recent underperformance, however, a Santa rebound has the ingredients for a stronger rally than usual. There appears to be some pent-up demand for a surge. After last week’s shift towards safe havens, a risk-on attitude could help several currencies.
What Could Move
One of the interesting cases to look at is gold. The yellow metal is seen as a safe haven, but last week its price actually went down during the risk-off move. That’s because interest rates in US treasuries rose, offsetting any potential gains for gold. Bonds pay a dividend, unlike gold, so they are usually more in demand when interest rates are higher. When interest rates fall, then holding gold is a better move.
Along with the Fed’s projection of fewer rate cuts than the market expected was the turmoil of a potential government shutdown that was narrowly avoided, and the resurgence of the debt ceiling problem. The political issues spilling into fiscal policy usually have the effect of raising interest rates as well. As a result, the dollar was one the largest beneficiaries of last week’s safe haven move, and could therefore be the bigger loser if risk appetite reasserts itself.
It’s the Economy
The other dynamic to keep in mind is that expectations for central bank moves of late are largely driven by economic performance. And since central banks set the interest rate that moves the currency, that’s what forex traders will focus on. We won’t be getting any major economic data, so a “risk on” attitude in the markets will likely rely on taking a more rosy outlook over existing figures.
With the overall economic narrative staying the same, the amount of impact of a risk-on move might be limited. That is, unless there is a major market event that shows up unexpectedly. And with Trump now the elected President, the chance of a market moving surprise is higher than it was last year.