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12/7 – 12/11 Global Market Outlook: Must-Know Dominant Forces & Implications

NB: The below is a brief summary of our outlook for global stock, commodity and currency markets for the coming week. Those seeking details should refer to the full version posted at: 
As speculation about market reaction to the Dubai World debt delinquency for the coming week dominated our thinking last week, so the market's response to the wildly better than expected Non-Farms Payrolls data could well be among the dominant influences this week, as it may well have improved expectations about the recovery of the world's largest economy and consumer market.
We've stated repeatedly over the past months that for the USD to reverse its downtrend, it would require one of the following kinds of events:
  1. A panic event that caused a USD short squeeze as traders fled into the USD, and reminded traders that getting too short the USD under current market conditions of complacency, faltering risk appetite, and sovereign default risk could be dangerous.
  2. Firm evidence of improved fundamentals in the US economy that would move up interest rate increase expectations.
  3. A collapse of the Euro, which would force major USD support
Little over a week ago, the Dubai crisis gave us a brief example of the first, and Friday's jobs reports provided the second, the true significance of which will depend on whether it is followed by confirming improvements in jobs, spending, and other data in the coming months.
If that trend reversal occurs, it will reverberate throughout global stock, commodity, and currency markets, as we'll discuss below.
 In sum, a US recovery that includes employment would advance the eventual rise of US interest rates, and thus the USD, with possibly dampening effects on commodities that rose in response to USD weakness (like gold), stocks (they don't like rising interest rates) and various currencies that have risen in response to dollar weakness. More on this below in the respective stock, commodity, and currency sections below.
The Non-Farm Payrolls Report: Ups Expectations for US Economic Growth, Interest Rates, USD
Friday's US non-farm payroll (NYSE:NFP) report shocked markets, here's why:
·         Only 11,000 jobs lost in November, vs. a forecasted decline of 119K-125K. This was the best reading since December 2007, when the US gained 120,000 jobs, suggesting that both job losses, and by extension US interest rates, may be bottoming out.
·         The unemployment rate dropped from 10.2 percent to 10.0 percent.
·         There was also the 159k upward revision to the September and October data along with the sharp rise in temporary hiring and lengthened workweek.
Markets move with expectations, and the reports gave these a firm kick upstairs.
Up until now, no one believed in a near term recovery in the labor market, even relative optimists spoke about a jobless recovery. However all the above points contributed to the euphoric response the US jobs report this past Friday. While we are skeptical about the validity of the NFP figure, this is what the entire market uses to gauge employment. Therefore we have to believe in the strength of the number and the market’s reaction. As expected, rate hike expectations have increased significantly but they remain at low levels. The probability of a rate rise in March rose to 17 percent from 8 percent and a probability of a rise in June increased from 26 to 36 percent.
Follow Up From Consumer Spending and Future NFPs Means Everything
The long term significance for the USD depends on whether the unemployment rate continues to fall, job growth returns, and spending actually picks up. Although we won’t know if this happened until next month, investors will most likely behave as if the U.S. economy has really turned a corner as long as next Friday’s retail sales report does not disappoint. Given that the ICSC chain store sales report declined and the Redbook retail sales report increased, the degree of consumer spending last month is unclear. Aside from retail sales, the trade balance and the University of Michigan consumer confidence reports are the most important economic releases on the calendar.
Meanwhile it is also important to recognize that part of the reason why the dollar did not give back any of its gains is because equities ended the day virtually unchanged. When the stock market opened, it rallied significantly but then reversed as the dollar strengthened.
Because equities and the USD tend to move in opposite directions, (more often equities driving the dollar) if equities rise significantly in the coming week, the dollar could give back its gains. Equities rise with risk appetite, and the dollar usually falls with it.
While we believe that stocks drive the USD most of the time [see The Must-Know Connection Between Stocks and the USD], at times the USD influences stocks. However, many believe that a rising dollar is bad for stocks even in the very short term, so the idea can become self-fulfilling, despite its dubious logic in the short term. Thus it needs to be considered.
As noted in our discussion of the USD below, the U.S. Dollar Index is rapidly reversing up to its 50-day moving average and falling trend line, which together have served as strong downtrend resistance since a brief peak in April of this year. If the index makes it back above this 50-day average, it would be bullish for the dollar and signal a possible longer-term reversal.
Much of the underlying reason for this reversal is the growing chance that US employment and thus interest rates may be rising sooner than expected. Overall that's positive for the US and global economy, but certain sectors that have benefitted from low interest rates and the resulting low dollar may suffer, or at least lose some of their speculative froth.
Precious metals are likely to suffer most first. This is largely because of the extreme pessimism against the dollar that drove people into them in the first place and has much to do with the fragility of the recent rally, which now appears to have been pure momentum.

Industrial metals and energy stocks might also be vulnerable, though much depends on whether the effects of overall economic recovery boosting earnings, as one would expect it to do for these very cyclical stocks, outweighs the effects of a rise in interest rates and the USD.

 With energy at 11.3 percent of the S&P 500 and materials at 3.59 percent of the index, hits to these sectors could hurt the overall market. Add in the overweighting that many funds have in these sectors and the chance for a USD rise hurting stocks becomes higher.
Ultimately, it depends on what factors outweigh others: overall growth's positive effects on earnings vs. the negative effects of rising rates and a falling value of foreign currency denominated earnings.
The biggest forex events this past week were the markets' reaction to the Dubai World debt delinquency and the US NFP report, both of which addressed fundamental issues concerning the USD and thus most of forex trade, because the USD is involved in over75% of global currency trade.
The short version: currencies will be dominated by how markets digest Friday's US jobs report regarding risk appetite and the USD, particularly in light of the recent Dubai scare and persistent resistance for the S&P and EURUSD. There are a few possibilities.
  1. Traders get more bullish on the USD, as latest Dubai scare supports the USD as a safe haven, and the jobs reports supports the USD's chances for earlier than expected rate increases. The USD rises against most other currencies, especially the AUD, NZD, and EUR against which it's been heavily shorted.
  2. They interpret the jobs report surprise as a green light for another leg higher in risk appetite. If traders revert to seeing the USD as a safe haven currency, the USD would then give back recent gains and could easily resume its downtrends against most other majors.
  3. However both of the above beliefs could prevail. This would mean a rare though conceivable lift for both risk currencies AND the USD, to the detriment of the JPY and CHF, as USD shorts unwind into these as the new funding currencies for carry trade.
  4. Dubai and the jobs reports quickly become old news and current trends continue.
Regardless of which of the above prevail over the next week, the longer term trends will depend on which combination of the three key kinds of events mentioned in the introduction dominate (panic event, improvement in US economic and USD fundamentals leading to higher rates, EUR collapse) forex markets.
We suspect a combination of the first two. However, a debt payment delinquency or default from Greece or another weak EU member could give the EUR and global risk assets a nasty shake.
In sum, we suspect that events favor the USD, which may be due for a period of stability or even rally in the coming weeks.