By Bloomberg News
(Bloomberg) --Will the stock market’s record-breaking rally stumble? Is the dollar doomed again? How flat can the Treasury curve get?
The list of market trends investors have to digest as the New Year dawns is long, and assessing them will depend on how this year’s themes -- from Federal Reserve rate hikes to stretched market valuations to major U.S. tax reform -- will play out in 2018.
To give investors a better grip on such concerns, we’ve pulled together what our strategists and reporters see as some of the most important charts to watch next year.
- For a tell on whether this equity market -- characterized by relentless rotation and low volatility -- truly shifts in 2018, watch to see whether an external shock or event risk is strong enough to overwhelm this year’s bullish narratives all at once -- or for signs they have fully run their course.
- The secret to U.S. stocks’ success in 2017 was rotation. The above chart shows that the KBW Bank Index, QQQ (the ETF that tracks the Nasdaq 100 index), and the Energy Select Sector SPDR fund have only seen two sessions in which all declined by 1 percent -- compared to 14 such instances in 2016 and 20 in 2015.
- This dynamic has helped keep implied volatility at ultra-low levels throughout the year.
—Luke Kawa, markets reporter
- The U.S. bond market has seen its volatility fall off a cliff this year, as reflected by the Merrill Lynch Option Volatility MOVE index, to hit all-time lows. This has been driven by gradual economic growth, tepid inflation, the FOMC’s forward guidance and amid the hunt for higher yields.
- In order for volatility to return to the rates market, the curve will have to steepen, but it’s currently showing no signs of doing so with long-end yields anchored while shorter-dated maturities brace for further rate hikes.
- Even though eurodollar options activity is starting to show signs of hedging against higher Fed rates -- banks such as Goldman Sachs Group Inc. and Deutsche Bank AG are starting to plan for as many as four rate increases in 2018 -- eurodollar spreads remain flat. This has attracted some bets on the front-end of the curve to steepening into 2018 as the overnight interest-rate swap curve continues to price in hikes at a slower pace than the Fed.
—Edward Bolingbroke, Treasuries and rates reporter
- Another key for investors will be to suss out the direction of prices, whether the reflation narrative takes hold or it’s just a head fake.
- Consumer prices may be on a trend that will take them above 2016 levels, which could cause the Fed to either hike more aggressively or watch the yield curve steepen.
- However, there is a possibility inflation is still trending down. That could cause the Fed to either quit the hiking cycle or risk an inverted curve.
- And there’s a third option, inflation may simply move back into its range from 2016, which would mean no real volatility in 2018 for currencies and rates.
- The prevailing view from analysts surveyed by Bloomberg is that the inflation rate will rise to 2.2 percent next year and hold through 2019.
—Jacob Bourne, currency and rates strategist
- Gold has been trending lower since peaking for the year in September. That may be about to change.
- The metal has already bounced off two key support levels: the Fibonacci 50 percent retracement from December 2016 lows to September 2017 highs and the confluence of a second Elliott Wave.
- On the fundamental side, investors may buy more of the commodity in the new year as a hedge against inflation that’s been forecast by the Fed to continue to accelerate.
- Geopolitics could also spur gold prices higher in 2018. The precious metal spiked throughout the year on headlines tied to North Korean tensions, and there is no sign that will abate into next year.
—Vincent Cignarella, currency strategist
- The JPMorgan Global FX Volatility Index, which is a barometer of expected foreign-exchange volatility over the next three months, is around a full standard deviation below its 20-year historic average as traders become more convinced that currencies will remain stable well into next year.
- Their optimism may be dashed if Treasury yields and the dollar rise in tandem as a result of tightening U.S. financial conditions after the potential passage of U.S. tax reform.
- Historically, the peaks and valleys of the volatility index are inversely related to the Bloomberg Dollar Spot Index and U.S. financial conditions; thus, an around 5 percent gain in the dollar could see the volatility return to its mean with significant moves in emerging markets.
—Robert Fullem, currency options strategist
- When it comes to emerging-market currencies next year, just watch commodities. The link is easiest to see in Latin America, where raw-material prices are closely tied to long-term moves.
- However, politics should still play a major role. Nafta negotiations will continue to prod the Mexico’s peso, as will a presidential election next year. Brazil is still grappling with economic reforms and the country will also vote for a president.
- In Turkey, its currency has been correlated to its rocky relationship with the U.S., which has weighed on it over the last few months.
—Davison Santana, emerging-markets currency strategist
--With assistance from Jacob Bourne, Edward Bolingbroke, Luke Kawa, Vincent Cignarella, Robert Fullem and Davison Santana.To contact Bloomberg News staff for this story: Randall Jensen in New York at [email protected] To contact the editors responsible for this story: Jeremy Herron at [email protected] Randall Jensen, Brendan Walsh