Christmas Week Markets Were Silent; Fiscal Cliff Remains Unresolved

The passing week was characterized by, well, silence. Between Christmas and the market waiting on the sidelines for the Fiscal Cliff situation to be resolved, not much moved.

In Japan, following the elections to the lower house and Abe’s victory (and his demand for a 2% inflation target as well as more loosening monetary policy measures), the market awaits the January BOJ meeting. As the BOJ semi-officially reviews its inflation target once a year, that meeting timing sits well with the pressure we mentioned above from Abe. We assume that this change will yield little results for Japan anyway.

However, for a trader seeking to bet against the JPY, the problem is that the entire market has already put large bets in that direction. That means that the real value of the JPY post any future changes is “masked” by the long positioning. In addition, any positive surprise for the JPY will trigger many stop-losses.

In the US, the numbers we saw this week indicate the continuation of positive trends in American labor and housing markets. However, the political deadlock over the Fiscal Cliff continues to cast a dark shadow on the situation. Quite amazingly we have to admit, Washington politicians still engage in this high stakes poker game.

The markets are nervous (as implied by prices of options on American assets as well as highly-correlated foreign assets) as the prospects of a compromise in time for the end of the year seem slimmer and slimmer. The bets now are about the height and duration of the Fiscal Cliff fall, i.e. perhaps there will be a temporary fall from the Cliff before a compromise is reached.

We are very concerned about this possibility. Why? Because temporary things are the most persistent ones and there is no telling what future problems this will cause. With less than 48 hours left until the deadline, the possibility of a compromise definitely exists, but as the stakes are higher, no side wants to blink first and thereby imply a willingness to commit to concessions in upcoming negotiations.

Next week won’t be much different than the one we are reviewing due to the New Year. In the US, the December Unemployment and nonfarm payrolls numbers are expected on Friday. This will naturally take a backseat in favor of the Fiscal Cliff, but it is important to recall that a few weeks ago, Fed Chairman Bernanke revealed the Fed’s numerical unemployment level that will set off a rate change. 6.5% unemployment will allow the Fed to increase its rates as the FOMC views that level as a sign of economic expansion and the beginning of inflationary pressures.