Five things to think about this week:

BOND YIELDS 
- Nominal bond yields have risen across the curve, while term premiums and fixed income volatility are higher in an environment of uncertainty about how central banks will exit from quantitative easing policies once recovery takes hold. Bonds have turned into the worst-performing asset class this year according to Citi and none of the factors which markets have blamed for this are about to disappear. Curve steepening seen in April/May has started to reverse and whether it continues is being viewed as a more open question than whether yields head higher still.

RATTLING EQUITIES? 
- World stocks' are struggling to extend the near-50 percent gains seen since March 9 but they have yet to succumb to gravity despite a back up in government bond yields. Citigroup analysts reckon global equity markets can rally as long as Treasury yields stay below 5-6 percent but it might be the speed of yield moves that determines whether equities get rattled or keep looking past higher borrowing costs to the recovery story. 

INFLATION EXPECTATIONS 
-  Increases in the prices of oil and other commodities have seen the CRB index rise about 30 percent in less than four months and sustained gains will risk filtering through to prices and price expectations. Inflation reports are due out on both sides of the Atlantic next week but markets are looking further out and starting to price in the risks of a pick up in price pressures. Breakevens have turned positive all along the U.S. yield curve for the first time since autumn and euro zone breakevens have risen. Also, a Bank of England survey indicates public price expectations are up. Bid/cover ratios and tails at inflation-linked bond auctions will tell their own story on extent of demand for inflation hedges.

CENTRAL BANK POLICY 
- Futures pricing after the U.S. non-farm payrolls showed the ebbing and flowing of rate rise expectations in the U.S. and UK and a feedback loop is increasingly evident between markets, which are keenly attuned to every nuance of how QE exit strategies might play out, and policymakers, who are puzzled by what drove the dramatic swing in rate rise expectations and what is pushing up bond yields. Policymakers are treading a fine line between actions (pursuing QE) and anti-inflation rhetoric, and central bank reports (BOJ), policy meeting minutes (BOE, BOJ), and SNB policy meetings will shed more light on how they plan to manage this tightrope act. 

BRIC POWER 
-  FX reserve plans, IMF financing, and the nature of the new IMF bond are on financial markets' radar in the run-up to the first BRIC summit that will be held in Russia this week. How much the big emerging powers can agree on and how much unity they show at their first such summit will shape expectations of how much they can influence international policy and the market fallout of any proposals they table.

Five things to think about this week:

VOLATILITY
- World stocks’ near-50 percent gain since early March may be levelling off — investors have factored in much of the output recovery that is in the pipeline and fresh impetus could be needed from further improvements in economic indicators or the corporate outlook. With many fund managers yet to wade in with the cash piles on which they have been sitting, a bout of volatility looks more likely than a dramatic pullback.

GROUP OF 8
- Talk of green shoots of economic recovery has removed some of the threat of global economic meltdown and therefore reduced the pressure to come up with coordinated international policy response. The Lecce finance ministers’ meeting will test G8 nations’ commitment to putting up extra money for the IMF and an SDR allocation increase. The risk is that cracks appear on these and other issues (eg QE, fiscal stimulus, etc). Given expanded IMF resourcing was one of the planks on which the equity market/emerging market rebound was built, any signs of pullback could fuel volatility and throw up risks for the assets which have benefited most from that rally.

DOLLAR STANCE
- Asian reserve managers’ reassurance on Treasuries holdings came in the same week as rumblings of discomfort from some emerging market countries (eg South Africa, Israel) on the dollar’s slide and its fallout. Soothing noises from Asia about their dollar-denominated holdings and its FX impact risk being cancelled out by the chatter about international reserve currencies building in the run-up to the first BRIC summit later in June.

BALTICS AND THE FALLOUT
- How much international help Latvia gets to fend off devaluation pressures will determine fate of assets well beyond its own borders. CEEU assets as well as Nordics are affected by fallout and the ripple effects have been seen in euro zone countries with biggest exposure to Baltics and its banking sector.

DEBT ABSORPTION
- Strong demand for long-dated German and UK debt helped reverse part of the recent yield curve steepening. Fed, ECB and market watchers are having a hard time disentangling how much of that steepening was down to economic activity pick up expectations and how much should be attributed to issuance, longer-term price pressure concerns. The market’s appetite to absorb more long-dated paper (from U.S. and Japan this week) will shed more light on how soon central banks might have to fret about longer-term borrowing costs backing up.

(Reuters photo: Lucy Nicholson)

Analysts are starting to wonder if the International Monetary Fund will issue bonds denominated in its currency, Special Drawing Rights (SDRs), to boost the international lender’s capital. 

G20 leaders meeting today are said to be ready to agree a tripling of the IMF’s resources, to $750 billion. One source at the summit said the IMF might also tap international capital markets. 

BNP Paribas analysts like the idea of SDR bonds that could be bought by central banks reallocating portfolios away from the dollar. “Increased IMF firepower and the IMF likely to issue SDR-denominated bonds later this year will allow equities to move significantly higher,” they say in a client note.

Youssef Boutros-Ghali, Egyptian finance minister and head of the IMF’s policy committee, the IMFC, also likes the idea. 

“It’s an efficient means of financing the IMF,” he told Global Investing this week, adding that a bond tradeable by central bank members of the IMF would enable even smaller members like Egypt to contribute a billion here or there to IMF coffers. 

(Reuters photo: Bogdan Cristel)

The recent spate of shark attacks on Australian beaches could mark a turning point in global deflation and signal a change in fortunes for some beleaguered emerging economies, if Nomura strategist Sean Darby is to be believed.

Speaking at a Nomura investors forum, Darby said a chance sighting of a shark on Sydney’s famed Bondi Beach three weeks ago made him realise that prices of grain and other soft commodities — punished of late by global recession fears — could be due for a rebound.

“I actually saw a shark on Bondi Beach and that made me wonder about the impact of La Nina and how there’s a severe drought around the world at a time when many farmers are finding it hard to access credit,” said the Hong Kong-based analyst.

The La Nina meteorological phenomenon has been blamed for bringing deep ocean creatures — such as sharks — closer to shore and also for a long-running drought that has hit farmers in Australia, China and North America.

Persistent drought could push food prices higher, potentially benefitting soft commodity-producing economies from Vietnam to Ukraine, Darby said.

“This is one area that could disrupt the picture of global deflation that bond markets have,” he said.

Bond yields are on the rocks, prices are hitting the steepest slopes and credit derivatives are at an impasse. So what better way to spend the time than to join 200 bond traders for a skiing weekend in Switzerland?

Throwing caution, and the global financial crisis, to the winds, the International Capital Market Association, the self-regulatory organisation for capital markets, is holding its annual ski weekend in the Swiss resort of Villars, “set on a sunny plateau above the Rhone Valley, with superb views over the
Vaudois Alps”.

The association has been running ski events for members for over 30 years. “A packed programme of outdoor activities and entertainment starts with the welcome drinks and dinner on Friday evening … and gets into full swing with racing on Saturday.”

Government-backed lending programs around the world have sparked a revival in financial and corporate borrowing — for now. Worldwide sales of corporate bonds rose to $251 billion in January, the highest level since May 2008, marking the first signs of a thaw after a long global capital markets winter. The following are the global sales totals and a list of the biggest borrowers, according to Thomson Reuters data.

Read the full story here.

Top Temporary Liquidity Guarantee Program
(TLGP) Issuers

Corporate and Government Guaranteed Debt - Global

No sign at a Fitch Ratings briefing today that things will get much better this year for emerging market debt. The 100 or so mainly industry attendees were asked to give their thoughts using a machine not unlike the “Ask the Audience” gadget seen on “Who Wants to be a Millionaire”.

Only 10 percent said credit quality would improve over the next 12 months. By far the largest vote — 59 percent — was for credit quality to “deteriorate” somewhat.

 As for a wholesale crisis on emerging markets, the attendees were fairly sceptical. Only 12 percent thought there was a more than 50 percent chance of such event. Half the respondents said the odds were between 20 and 49 percent. SOme 38 percent said it was less than that.

Fitch, meanwhile, said it agreed that emerging market credit quality was likely to deteriorate further. It was corporate rather than sovereign debt that was most most likely to defauls. And emerging Europe was the most at risk.

Equities may be having a stop-start kind of month, but investors do seem to be more willing to take on risk than before. The latest numbers from EPFR Global, a tracker of investment flows, show high-yield bond funds raking in the money in the second week of January. A net $766 million flowed into the HY funds tracked by the firm. At the same time, a net $578 million flowed into U.S. municipal bond funds.

The drive behind these flows is a mix of a desperate search for yield and a belief that the risk might well be worth taking. Investment grade corporate debt is considered to be priced at Armageddon levels. That is, the price assumes too much trouble ahead than is likely. This has led, for example, to a monthly record in new bond issuance in January in Europe.

High yield is not pricing in quite as extreme a default rate from a historial perspective. But it is still evidently attractive, hence $3.38 billion in global net inflows over the past seven weeks.

Municipal bonds, meanwhile, may be getting a boost from expectations for the incoming Obama administration. EPFR says U.S. investors are anticipating higher taxes, which would help municipal finances.

Mike Trudel, U.S.-based managing director and senior product specialist at BlackRock, has become convinced the economic recession really has arrived.

When he checked into London’s hip upmarket hotel Sanderson earlier this week, the staff uniform caught his eye.

Hotel staff were wearing black T-shirts, with RECESSION written in big letters in front. They highlighted SI in red – like this:

RECESSION

“It read as recession is on. If folks in Sanderson know about it, it’s no secret anywhere else. That’s how awful it is,” he told a group of journalists at BlackRock’s London office.

However, Trudel thinks it’s time to get back into stocks. BlackRock’s Global Funds in which he is involved are overweight on stocks at 63 percent of the portfolio, underweight bonds at 29 percent and overweight on cash at 8 percent.

Republican presidential candidate John McCain has admitted in the past that economics is not his strong suit. In an interview with Reuters this week, he expressed a desire for a Treasury secretary who inspires confidence and trust if he should win the White House. McCain also aid he could balance the budget by 2013 if the economy gets going and if nothing is done to harm growth.Nothing worrying about any of that.

But the odd eyebrow may have been raised when the Arizona senator got onto the dollar, which he wants to bolster, and China. “The first step that has to be taken is obviously we have to stop mortgaging our economy to China … and asking them to finance our debt,” he said. This sounds like he wants China to stop buying U.S. Treasuries.

“That I think would have the most salutary effect in the short term,” McCain added.

China owned $518.7 billion of Treasuries at last count, or 19 percent of all foreign-owned U.S. government debt. Its purchases month after month have gone a long way to keep borrowing costs down for Americans and keeping the dollar up.  Economics 101 would tell you that if China did stop, rates would soar and the dollar would dive.