2007: The Final Cut

Housing news and interest rate decisions dominated headlines and market sentiment yet again last week. Its easy to forget that there were times when this wasn't the case.

Fear had free rein in the final quarter of 2007, as concerns over an all out collapse in the housing market, banking sector, and consumer spending drove the market lower. As the final month of the year approached, sentiment has changed quickly in lock step, with forward expectations for US interest rates.

Fed Futures markets are indicating that a quarter point cut is highly likely at this weeks FOMC meeting, but it is the chance of a half point cut that has got the market excited.

Last week, the UKs MPC cut rates by a quarter of a percent, halting an 18-month firming cycle. Many economists didn't predict the move, though there was a remarkably rapid change in sentiment in the days leading up to the announcement. Sterling traders certainly knew something was afoot, with the US Dollar/GBP exchange rate dropping 1.5% at one stage, the day before the cut was announced.

The FTSE rose rapidly going into the decision, but fell back sharply on the actual news. It seemed a classic case of buying the rumour, and selling the news. The cut will be welcome news for borrowers, as the housing market in the UK continues to show signs that it will go the same way as the US.

Sentiment is also becoming more positive for the banking sector, as banks produce better than expected results, and smaller than expected credit related write downs. Britains Royal Bank of Scotland announced that the amount it would be writing down is roughly half the amount analysts had estimated. In addition they said that 2007 profits should still be well ahead of expectations.

Seasonality may be playing its part with December being a good month traditionally. According to The Stock Traders Almanac, since 1950 when the Dow was down in November, it gains an average of 4.9% over the next two months. In fact, only twice has the December-January period been down following a negative November; in 1967 and 1969. December and January are seasonably very positive months in their own right, with the S&P 500 up 75% and 65% of the time respectively.

For data release, this week is as heavy as they come, with the aforementioned US interest rate statement on Tuesday. A quarter point cut is most likely, but with a 20% chance of a half point cut, the reaction could be volatile to say the least.

In addition to announcing the next level of interest rates, the Fed will also be releasing their decision on the discount rate. This is the interest rate that banks can borrow from the FOMC. Many analysts are expecting this to be cut by twice as much as the headline interest rate, which would be good news for US banks.

This week there is also US pending home sales on Monday, trade balance on Wednesday, Core retail sales on Thursday, and Core CPI on Friday. With a top tier US economic announcement every day this week, its unlikely to be quiet on the US markets.

Traders at BetOnMarkets.com predicts that an up or down trade is a volatility trade that returns profits if either of two points are breached. An up or down trade on the S&P 500 over 10 days with the two triggers set as 1460 and 1545 returns 9%.

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