MacroScope

The Big Five: themes for the week ahead

June 15, 2009

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.

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