Why plunging oil has derailed the Santa Claus Rally - DailyFX Tips & Picks

WHILE children look forward to Christmas Day, many grown-ups are more excited by the Santa Claus Rally. This usually entails a nice boost to stock markets at the end of the year, generating a good return. But the FTSE 100 is down this month – someone has clearly been naughty.

And the culprit is said to be the tumbling price of oil, as lower energy and commodity prices have a direct link with the FTSE 100. Yet weak oil has not only caused the basic resources sector to decline. It has also affected many other sectors, as markets start to price in systemic risk.

The systemic risk arises from the fall in the Russian rouble, which has lost 43 per cent of its value against the US dollar year-to-date. Further, while it’s less important, markets are now predicting a 97 per cent likelihood of Venezuela defaulting over the next 12 months. With this in mind, many are ignoring the benefits of lower energy prices and instead focusing on the possibility that the weakness of Russia will pull everyone else down. This happened in 1998, when Russia defaulted on its debt.

Yet while lower energy prices create losers, they also create winners. The consumer is certainly likely to gain, and the $40 decline in oil prices is expected to greatly boost world GDP. This is a reason to be bullish on stocks. Further, lower inflation may prompt the ECB to act, and cheap money is something that the markets clearly like.

Will low oil cause Russia to default? I don’t know. But if it doesn’t, we will still be in a situation with decent growth, low inflation, and potentially a nice QE boost from the ECB.

Alejandro Zambrano is a currency strategy analyst at DailyFX.com.

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