While the Santa Rally, or the December Effect as it’s sometimes known, is most known in the stock market, it can also have an important impact on currencies.

With the US markets set to have the best performance since 2013, we could see some extra interest in this phenomenon.

What Exactly is the Santa Rally?

There is no formal definition. However, it has been noticed that as the year comes to an end, stock markets tend to perform better than average.

The FTSE 100, for example, rises 80% of the time come December.

Why? Well, it’s not people imbued with holiday cheer, unfortunately. It’s actually because of much more mundane and, frankly, bureaucratic reasons.

1. Taxes
   Many stockholders will adjust their portfolios ahead of the end of the tax year, closing out certain trades to get the best tax situation.
2. Accounting
   Investment funds tend to pour into the market in January as institutions take their annual positions. Of course, traders want to get a jump on the move, so the market rises in anticipation.
3. Appearance
   Fund managers will often buy better-performing stocks to have them in their portfolio at the close of the year, just so they can look good.

How is it Relevant Now?

Well, we can expect between a 1-2% increase in most stock markets if Santa puts them on his nice list.

For the US, in particular, this is interesting because indices are already off to a good start. Stocks hit a new record in late November. A correction lasting into the first couple of days of this month followed.

But, since then, things have been climbing.

In the case of the S&P500, hedge funds have been pulling their funds out of the market at a record pace, even as it grows. This suggests profit-taking ahead of the end of the year. And, we can interpret this as a sign of a larger inflow of funds in January.

And the Fed?

The Fed’s last meeting of the year comes a little ahead of when we might see the December effect. The consensus is that they will hold a neutral stance this time around, especially after the knock-out job numbers last Friday.

However, this might actually be seen as a good sign for the forex market, which was already adjusted to a rate hold. Good jobs and consumer confidence numbers ought to predict good stock market numbers in the near future.

And Currencies?

The Santa effect is similar to a risk-on environment. And we’d expect currency pairs to behave accordingly!

We would expect the dollar to be weaker against more risk currencies, as well as the yen.

We should note the rise happens when many major forex traders. Often the more risk-averse have already closed out their positions to take a couple of weeks off for the holidays.

Liquidity tends to dry up as the new year approaches, allowing for some more radical and unexpected moves in the currency markets.