Omicron developments maintained major uncertainty over the outlook across major economies, increasing difficulties in asset allocation.

There was choppy trading during the holiday period, especially with year-end position adjustment an important element. Omicron developments maintained major uncertainty over the outlook across major economies, increasing difficulties in asset allocation.

Markets continued to expect an early Federal Reserve interest rate increase in 2022. US bond yields moved notably higher with the 2-year rate at the highest level since March 2020 and 10-year yield at 5-week highs. Wall Street equities were notably resilient despite concerns over Fed tightening with fresh record highs for major indices.

The dollar dipped lower into year-end before recovering after the holiday period as higher yield provided crucial support. EUR/USD strengthened to highs at 1.1385 before a retreat to below 1.1300. Sterling secured net gains into the year-end period with EUR/GBP dipping to fresh 22-month lows below 0.8400. After gains into year-end, commodity currencies dipped lower as US yields increased.

The US core PCE index increased 0.5% for November with the annual increase strengthening to 4.7% from 4.2%. This was above consensus forecasts of 4.5% and the highest rate since 1983, maintaining pressure on the Federal Reserve to tighten policy. Initial US jobless claims declined to 198,000 in the latest week from 205,000 while continuing claims declined sharply to 1.71mn from 1.86mn and well below consensus forecasts.

Business surveys remained strong with the Richmond Fed manufacturing index strengthening to 16 for December from 11 previously while the Chicago PMI index advanced to 63.1 from 61.8 the previous month. The data maintained confidence in the US labour market and business conditions. Markets continued to monitor US and global coronavirus developments, although position adjustment was a key element late in 2021 with choppy trading conditions.

EUR/USD found support at lows around 1.1275 ahead of the New-Year holiday with a strong advance to 1.1380 on the final day of the year. The dollar was undermined by robust risk conditions and US selling on seasonal grounds which helped trigger a covering of Euro shorts and European gas prices declined sharply.

EUR/USD was resilient despite further concerns surrounding near-term coronavirus trends, but was subjected to renewed selling after the New Year holiday with a slide below 1.1300. The dollar was boosted by renewed demand at the beginning of the year while commodity currencies also lost ground. EUR/USD was able to resist further aggressive selling on Tuesday, but traded below 1.1300 with markets focussing on inflation and employment trends as choppy trading conditions continued.

The US goods trade deficit surged to a record $97.8bn for November from $83.0bn the previous month as exports declined 2.1% while imports increased 4.7%. Markets are taking little notice of overall trade balances, but there will be concerns over supply-side issues and the deficit surge could potentially undermine the US currency.

China’s PMI manufacturing index edged higher to 50.3 from 50.1 previously while the non-manufacturing index secured a slight improvement to 52.7 from 52.3 with both figures marginally above consensus forecasts. There were still some reservations over potential coronavirus trends in China if the Omicron variant takes hold.

USD/JPY strengthened to above 115.00 as risk appetite remained firm and 10-year yields held above the 1.50% level.

USD/JPY posted a further limited advance to 115.30 on Monday as a further increase in yields offset coronavirus reservations while Wall Street posted net gains.

The Chinese Caixin PMI manufacturing index strengthened to 50.9 for December from 49.9 and above consensus forecasts of 50.0 which helped underpin risk appetite. US yield remained higher on Tuesday with the 10-year yield around 1.63% and the 2-year yield at the highest level since March 2020. Higher yields again boosted the dollar with the USD/JPY at 5-year highs around 115.80 while EUR/JPY strengthened to near 7-week highs around 130.85.

Nationwide reported an increase in house prices of 1.0% for November with a year-on-year increase of 10.4% from 10.0% previously as asset-price inflation continued.

During the holiday period Sterling was supported by robust risk appetite as equity markets posted solid gains and the FTSE 100 index advanced to a fresh 22-month high. There was also evidence of a covering of short positions as the dollar lost ground.

CFTC data recorded an increase in short Sterling positions to near 58,000 in the latest week from below 51,000 the previous week and the largest short position since October 2019. The aggressive short position will maintain the risk of short covering if there is a shift in sentiment and UK currency gains.

Markets inevitably remained uneasy over the UK coronavirus trends given the on-going surge in cases. GBP/USD was unable to hold above 1.3500 as the dollar posted gains, but GBP/EUR registered a fresh gain to near 1.1930.

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