Monday Notes for the Week

Some comments about the markets for the week:

- Markets have started the year very well, and technically the rallies underway ought to be challenged soon, implying a cool off in returns and a possible brief sell-off. We remain bullish expecting the recovery trade to continue; I question its sustainability long-term but it looks strong short-term. If this is the case, any selling is a chance to increase exposure.

- Key events for the week include, the ongoing Greek debt negotiations, the FOMC meeting and the earning season. The European Finance Minister meeting is also of interest.

- Key data include US 4Q11 GDP on Friday, European consumer confidence & PMI, US pending home sales. Much of Asia is closed all week for New Year celebrations.

On Greek debt talks, agreement seems very close, with $200bln worth of bonds to be written down by 70%. This would be a mild positive if it gets approved, as it is enough to sustain hope of a Greek solution, although its long-term durability is unclear. If the deal fails, the markets will turn negative quickly.

The FOMC meeting is the first at which Fed chiefs will announce forecasts of how they expect interest rates to evolve. Our investment team is divided here, but my view is that it will weaken the dollar, at least temporarily. My reasons are that: 1) we know Japan killed its QE driven recoveries by raising rates too early, and 2) there is a lot of fiscal tightening scheduled for 2013 in the US.

For EURUSD, there is a lot of risk ahead of the FOMC news due on Wed. We would definitely consider selling out-of-the-money FX Targets (sell EUR, buy USD) if the rate gets to 1.32, which is the current technical roof. However, if the rate breaks through there, then higher EUR is again possible. Medium- to long-term we are still dollar bulls, but the EUR is still oversold and macro events are likely to dominate implying a wide range of possible outcomes short-term.

There is also a good chance the equity market will be supported if the Fed suggests further delays in rate hikes this week (extending the expected hike date from mid 2013).

The bulk of S&P 500 companies will report this week, watch your favourite names, and the aggregate levels of surprise. Overall, I expect earnings to be neutral for markets. But I am watching Apple and McDonalds with interest this week (both on Tues).

In Europe, the sense that we are getting into a safer zone should continue to support markets, most of the rally of the last week was in financials. If that trend continues through the middle of this week, it may also feed into other sectors that are under-valued. But for now the market continues to worry about recession in the real European economy, which will heal slower than the financial sector.

With the financial markets healing fast, we continue to expect peripheral (ex Greece) bond yields to improve. Mario Monti’s marketing campaign has also been an impressive stimulant of Italian bond demand.

Long-term we are still nervous about the sustainability of the European situation, but short-term there appear to be healthy drivers across the board.