The Big Five: themes for the week ahead

May 18, 2009

Five things to think about this week:
    
PUTTING THE RALLY TO THE TEST
- The surge in risk markets has tapered off as investors take stock of recent weeks’ rally and the data flow injects a dose of sobriety. The scale and duration of any market pullback will be the test of how much sentiment has really changed. Sluggish April U.S. retail sales were the biggest cause for pause and this week’s flash PMIs will give more Q2 information.

FX FOCUS
- A pause in the recent recovery in relatively risky markets is shifting attention to the changing FX environment. Clear-cut correlations between moves in major FX rates and swings in risk appetite could be in the process of being eroded and some in the financial markets are wondering if and when relative economic performance will replace risk appetite as a driver for exchange rates. Investment flows will be affected if the dollar looks like it might resume a long-term downtrend.

QE EXIT STRATEGY
ECB, BOE, Fed officials are making reassuring noises about QE exit strategies but no clear mechanism or timeframe has yet emerged and all indications are that balance sheet expansion is still the order of the day. Yield moves suggest bond markets are more enthused in the short term by signs they will kept on the QE drip feed than by concern about the potential price problems down the road. Central bankers have yet to address the back up in yields that would be seen if they were they to exit the market at a time when debt issuance is continuing to flood the market – as it will for some time to come.

BATON PASSES TO EUROPE
- Post-stress test capital raising by U.S. banks will put the spotlight on European banks’ balance sheets, not least given the EU version of the stress tests looms and IMF estimates suggest euro zone lenders have more toxic assets to write down than their U.S. and UK peers. But timing is everything and few would want to try to catch up with U.S. banks’ tier 1 capital ratio building just when the equity rebound runs out of steam.

BRICs
- The dollar’s retreat could see money which had been repatriated to the United States start to flow out again, potentially to the benefit of emerging markets. While BRICs have led the emerging market bounceback so far, India has lagged Brazil, Russia and China considerably. Now that elections are out of the way, it will become clearer how much of the Indian underperformance is down to political uncertainty.

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