Monthly Market Outlook

In December, with the signaling of the end of the hiking cycle by the FED and ECB, the market’s early rate cut expectations reached another level, causing gold and stocks to surge while the dollar weakened. The change was swift, despite central bank members repeatedly warning that the expectations were unrealistic.

In January, depending on the inflation and jobs data, the enthusiasm will either continue or the expectations might be trimmed a bit towards reality. The final days of the EURUSD showed the market’s indecision with sharp movements in either direction on low volume. On top of this uncertainty, the end of the two-step stopgap is approaching as well.

Macro View

The FED and ECB are at the end of the hiking cycle, and markets have embraced the rate cut expectations for 2024, perhaps a little too enthusiastically. The Federal funds rate forecast indicates that members have projected 3 cuts for 2024, marking a increase of two steps from the forecast in September. The core inflation forecast has also been revised downward to 2.4% for 2024 and 2.2% for 2025. The main focus of the FED may be shifting towards the job market, which continues to exhibit strength well above average.

However, the markets are pricing in a substantial number of rate cuts, anticipating six or more for 2024 starting from March. There exists a significant divergence between the FED forecast and market pricing. This considerable gap may likely be corrected in early 2024, possibly this month. The speed at which this correction occurs might determine the market’s reaction to the dollar index and stocks. Currently, the expectation of six or more rate cuts seems very unrealistic without a significant recession. Although the 2 and 10-year government yield gap is still below “0,” it is much closer to it relative to a couple of months ago. Despite some warnings from household balances, a strong job market, and the resolution of inflation are keeping households positive about consumption. The recession expectation is fading for now, which contradicts the expectation of rate cuts. Additionally, many FED members have cautioned that the market expectations about rate cuts are “unrealistic”.

The job market remains remarkably robust, particularly when considering the prevailing level of unemployment. The upcoming jobs report for the first week of the year will play a crucial role in shaping January’s price movements. A positive report has the potential to disrupt overly optimistic expectations of rate cuts and initiate a possible market correction. Conversely, a weak report could reinforce these expectations, leading to significant trend changes for various securities.

While recession fears are easing, the track record of rate hikes serves as a warning for traders. Excluding the COVID shock, in the last two recessions (highlighted in red), the Fed had already concluded its hiking cycle, and unemployment had dropped to multi-year lows before rising rapidly. This pattern prompted the Fed to cut rates very aggressively but proved insufficient to prevent the recession. While there are various elements in this cycle, this track record can be viewed as a cautionary signal for traders. If the Fed maintains high interest rates for too long, another recession may be on the horizon.

The Eurozone continues to show negative divergence, as per the latest PMI data. The manufacturing sector is still experiencing a decline in activity, primarily driven by Germany. Budgetary issues could exacerbate the challenges facing the recovery. In China, despite maintaining a PMI above 50, there are several vulnerabilities in its economy, and the recovery has been more severe than anticipated. The U.S. economy has been one of the most stable so far, but the potential impact of higher rates on tightly stretched sectors could be significant. If the Fed maintains high rates for too long, PMIs might offer an early signal if conditions start to deteriorate.

Similar to the Fed, there is a significant surge in rate cut expectations for the ECB in 2024. The first cut is anticipated in March, with a 64.6% probability according to swap market pricing, and projections indicate 6 or 7 cuts by the end of the year. While the markets anticipate these cuts, the ECB has partially rolled back its PEPP reduction, initiated half a year ago, with small adjustments at the outset. Members have consistently emphasized that early cuts are not on the agenda, contrary to market expectations. The Eurozone economy appears weaker relative to the US, and the ECB might be compelled to implement cuts in March or April if the situation does not improve.

In Japan, the BOJ has maintained a dovish stance and made no changes to its extremely loose monetary policy. However, the latest remarks from Ueda once again provide hope for Yen bulls. Ueda signals that the BOJ may not need to wait for all of the medium and small wage negotiations and could decide on changing policy as early as April. Jobs data from now until April could have a significant impact on both the Nikkei index and the Yen moving forward.

Central Bank Meeting Calendar

Technical View

The US 10-year government bond yield tested the 5% barrier multiple times in October and at the beginning of November. Subsequently, there was a significant reaction, and the current supports are struggling to sustain the recent decline in yields. The next levels to monitor as potential supports are 3.62% and 3.18%. If the momentum begins to wane, this could serve as a warning sign for the end of the stock market surge as well. Therefore, FX and stock traders should remain vigilant and closely monitor possible trend changes in government bonds in early 2024.

Brent continues to fall in an orderly fashion. The downtrend channel is functioning almost perfectly, and the retreat might extend as much as $70. Brent bulls should be vigilant for a breakout of the trend and the regaining of $79 for more than a couple of days to ensure some safety. Currently, the trend, momentum, and supply-demand dynamics still favor oil bears.

Precious metals have benefited from a weaker dollar index, as gold continues to test the 2075 resistance with a monthly return of 1.30%. Platinum, and especially Palladium, experienced significant reactions with returns of 6.7% and 8.98%, respectively. The downside for metals, however, is that silver, often an early indicator for metals, fell sharply in December

The gold/silver ratio and gold’s negative correlation have deviated from their standard averages, with the ratio remaining slightly positive while gold has surged dramatically in the last few months. Whether this is a temporary divergence or a sign of something more significant changing is not yet clear. If it is the former, a sharp correction for gold or a surge in silver might be due in early 2024.

Despite receiving support from fund managers, ETF gold holdings remain at lower levels despite the price surge. The significant selling from ETFs raises further questions about gold’s upward moves.

Gold continues to aggressively test the substantial 2050-2075 resistance zone. Throughout December, gold breached this zone twice during periods of low volume—once early on a Monday and once during the holiday week. Both attempts fell short, leading to a price retreat. However, there is undeniable upward pressure persisting, propelling the price higher despite weaker fundamentals. In January, it is crucial to monitor the significant levels at 2075 and 2140. A breakout with higher volume could signal a potential reversal in the first quarter.

Silver‘s ABCD formation worked perfectly, leading to a decline of more than 12% at the beginning of December. Since then, silver has been in desperate need of direction. Despite the weakening dollar index, silver has been unable to regain lost momentum. The level to watch is 23.20. If the ongoing shaky uptrend channel fails, another downward movement could occur. However, as long as it holds, and depending on US data and debt ceiling talks, silver might start to recover once again.

The dollar index extended its losses in December, falling more than 5% from early November. The 101 support level may be one of the stronger ones. During the first half of 2023, this support repeatedly held off downward moves, only being breached in July for a brief one-and-a-half-week period. Thus far, there has only been one day with a close below it, and it was just barely below. As long as it holds, there is a good chance for the dollar index to initiate a move towards its moving averages, particularly the 200 DMA. However, a break below could push the price down to 99.50 first, and potentially further, depending on incoming data.

The stock markets continued their rise in December. As the holiday week began, the momentum eased. The MSCI World Index rose by 5.15% last month, with Dow Jones leading the charge with nearly a 7% return, while Nasdaq continued to capitalize on the AI rally. Starting in 2024, stocks might have to decide whether to take some profit after the massive run or push the rate cut narrative further and make another leg upward.

The VIX index is contracting but remains very low, hovering just above 11.50. Any sudden jump, with a potential minor downward reaction from the S&P 500, is expected to be limited if the soft landing narrative continues. Levels at 18.75 and 21 could be followed as further danger signs for stocks. As long as the VIX stays below these levels, dip buying strong supports could remain the main gameplay.

The S&P 500 continues to deliver solid returns, benefiting from early rate cut expectations, a weak dollar index, and an AI boost. However, the index has reached critical levels that could potentially slow the upward momentum or even temporarily reverse it. Around 4820 (4820-4850), the first resistance has been tested many times in the second half of the month. If a clear breakout occurs, the next stop will be a key zone containing multiple resistances, such as the upper line of the trend channel, Fibonacci 76.4% extension, and the psychological level of 5000. This zone has a high chance of halting the index’s further extension for now and would require significant strength to break. Regarding downward moves, the 21-day moving average could be the first signal for a momentum shift, while 4670 – 4565 might serve as supports to monitor in January.

The FX market enjoyed another month of a weak dollar index. The AUD continued its strong performance, but the real winners were the JPY and CHF, with returns of 5.62% and 4.70% against the dollar, respectively. The EUR was weak but gained 0.88% against the dollar.

EURUSD reached above 1.11 in December during the low-volume market but was unable to hold onto it. The EU economy is still weak, but ECB members remain relatively hawkish, which is keeping upward pressure on EURUSD high. However, if the overextended rate cut expectations normalize for both the FED and ECB, EURUSD has the potential to fall towards the key moving averages just above 1.08. For upward moves, the upper line of the trend channel, the broken trendline from earlier, and the 1.10-1.11 horizontal resistance zone have converged, creating significant resistance. Multiple closes above 1.11 could be a signal for further upside, if it happens.

EURUSD has been in a long-term downtrend since 2008. Currently, the price is near the trendline, just below 1.1410. Whenever the trend is tested with a small or larger margin, Euro net long positions in the futures market seem to reach their peaks. As the price decreases, the positions at the tops increase. So far, the trend has persisted, and the downward moves from the tops have been significant, ranging from 14% to 24.57%. The last occurred during the Covid-19 pandemic, and EURUSD retreated nearly 21%, falling below parity. Now, EURUSD is once again close to the trendline with very crowded net long positions. A break or a fall situation might commence in the first quarter of 2024.

EURUSD continued its positive seasonality at the end of the year and is now entering a possible negative season, particularly for February. Over the last 10 years, EURUSD rose in January only 4 times and in February only twice. The negative seasonality, coupled with crowded net long positions, overextended rate cut expectations, and strong resistance levels, might dampen the enthusiasm of EUR bulls in the first quarter. This, of course, depends on the US jobs and inflation data.

USDJPY broke the uptrend channel, and with Ueda’s recent remarks signaling a possible policy change in April, the trend has completely shifted. For 2024, the massive upward pressure might end with the Fed starting to cut rates while the BOJ looms with an exit from ultra-loose policy. In January, support levels to watch are 139.57 and 137.50, but downward moves could further extend depending on data, especially Japan’s employment data. The previous downward move extended as much as 1.4 standard deviations from the 200 DMA. A similar case could be in play this time as well. For upward moves, capturing and holding the 200 DMA will be crucial.