MacroScope

Having wrapped up the two-day get-together in London, G20 central bankers moved down to the Swiss city of Basel (I counted central bank governors and officials from at least 9 countries onboard the same flight) to discuss more about the global economy for a two-day meeting.

The focus here again is the global economic recovery, which seems to be gathering momentum, and the timing of exit policy — which is essential in the future to avoid inflationary pressure.

The mood is decidedly more positive this time than the last time they met in Basel, where they warned that unprecedented attempts to stimulate economic may fail to bring a sustainable recovery.

G10 chairman and ECB President Jean-Claude Trichet will give a briefing on Monday.

Trichet has recently been sounding as if he expects a double-dip recession, as our European affairs columnist Paul Taylor suggests here.

Finance ministers from the G20 are meeting in London on Friday and Saturday to discuss the next steps in battling the world’s worst economic and financial crisis since the Great Depression.

Reuters correspondents from around the world will be at the event, taking you behind the scenes and and providing unprecedented coverage through this live blog.

G20 Finance Ministers Meeting in London

Finance chiefs from the G20 meeting in London on Friday and Saturday are likely to be in a slightly better — or at least more relieved — mood than they were last time they got together.

The world economy is still in a mess and the financial system is far from running normally. But — and it is a big but at that — fears of global economic collapse have dissipated. This is in no small part as a result of the actions of groups such as the G20 which endorsed coordinated intervention into the marketplace.

So much so, in fact, that much of this weekend’s discussions will touch on the so-called exit strategies that countries will need to get themselves back out of the stumulus and bailout business. With markets in mind, they are likely to be coy about it.

Five things to think about this week:

CENTRAL BANKERS IN A HOLE
-- The global economy and financial system appear on the road to recovery but that is in large part due to unprecedented official stimulus that will have to be withdrawn at some point - the questions investors want answered are when, and how.  Central bankers no longer appear to be quite as shoulder to shoulder with one another on coordinated policy as they were last year in the aftermath of Lehman's collapse.
 

CHINA STOCK WATCHING
--  It is August, liquidity has dried up with the summer holiday season in full swing, and investors are palpably more cautious about the economic outlook now than they have been for months. It is against this backdrop that that the Chinese stock market is emerging as the focal point and driver of all other asset markets. The Shanghai Composite technically slipped into bear market territory earlier last week, shedding 20 percent in the two weeks from Aug. 4 to Aug. 19 on profit taking from the 90 percent surge this year. There is no major Chinese economic data scheduled for release this week, leaving thin markets at the whim of sentiment in what is a notoriously volatile stock market.
 

GROWTH FOUNDATIONS
-- The United States, Britain and Germany unveil revised estimates of Q2 economic growth. Revised GDP figures rarely garner much attention but with initial estimates from Germany, France and Japan earlier this month all showing that these countries exited recession in the last quarter, investors will be looking for further evidence the world economy has turned the corner. The hard data is stronger now than it has been for some time but is the global economy building a solid base for recovery, or is it more likely to buckle were authorities to begin withdrawing the massive fiscal and monetary stimulus?
 

Professor Charles Goodhart of the London School of Economics explains the difference between inflation targeting and price level targeting in the lobby of Jackson Lake Lodge after taking part in an animated discussion of whether central banks should target price levels rather than inflation.

A paper University of California, Santa Cruz economist Carl Walsh presented at the Federal Reserve’s annual mountain retreat suggested that one lesson from the recent financial crisis is that central banks would benefit from the greater flexibility that price level targeting might give them.

A former Fed governor,  Frederic Mishkin, said that while in theory price level targeting may sound attractive, in actual practice it is more difficult to use effectively. One difficulty he cited was in explaining to consumers how it works. 

Five things to think about this week:

APPETITE TO CHASE? 
- Equity bulls have managed to retain the upper hand so far and the MSCI world index is up almost 50 percent from its March lows. However, earnings may need to show signs of rebounding for the rally's momentum to be sustained. Even those looking for further equity gains think the rise in stock prices will lag that in earnings once the earnings recovery gets underway, as was the case in past cycles. The symmetry/asymmetry of market reaction to data this week -- as much from China as from the major developed economies -- will show how much appetite there is to keep chasing the rally higher. 

TAKING CONSUMERS' PULSE 
- A better picture of the health of the consumer will emerge this week as U.S. retailers' earnings coincides with the release of U.S. July retail sales data and the UK BRC retail survey comes out on the other side of the Atlantic. With joblessness still rising, the reports will show how willing households are to spend and whether deep discounts, which eat into retailers' profit margins, are the only thing that will tempt them to shop -- both key issues for the macroeconomic and corporate outlook. 

CENTRAL BANK WATCH 
- After last week's Bank of England surprise, all eyes turn to what sort of signals the U.S. Federal Reserve and Bank of Japan will send on the outlook for their respective economies and QE programmes. After the BOE's expansion of its QE programme the short sterling strip repriced how soon UK rates would rise. But the broader trend recently in the U.S., euro zone and the UK has been to discount rate rises in 2010 -- and possibly as soon as this year in Australia. Benchmark interbank euro rates have risen for the first time in two months, and central bankers everywhere, including China, face the delicate balancing act of managing monetary tightening expectations in the months ahead. 

Central bankers have not had much reason to be happy over the last two years, as the financial crisis has lurched from bad to worse.

But the European Central Bank at least is now finding comfort in the fruits of its injection of close to half a trillion euros in 12-month funds last week, which has pushed money market interest rates to new record lows. 

“We are very happy, we see clearly that we decreased the risk premia,” ECB President Jean-Claude Trichet said on Thursday, after the ECB kept its benchmark rate on hold at 1 percent.

Five things to think about this week:

STALLING RALLY
- The global equity market rally has stalled in June and is threatening to go into reverse. With this week effectively the last full week of the second quarter, the temptation for many funds to book profits on such a lucrative quarter will be high. Any knock on boost to volatility would pose more risks for some of the trades that looked the most attractive in a lower volatility environment, such as cyclical versus defensives plays, emerging markets, and foreign exchange carry trades.

POLICY, SUPPLY RISKS FOR BONDS
- How the U.S. Federal Reserve will respond to the interest rate market gyrations of the past month has been a key market talking point. Questions centre on whether it will expand the size of buybacks, whether there will be any change in the length of time the buyback programme lasts, whether the central bank makes any effort to unwind the rise in bond yields seen in the past months, and whether there will be any talk of an exit strategy. Another risk to the front end will be the Treasury refinancing, which resumes after a week of no supply and will be concentrating on the shorter end.

WHAT COLOUR ARE THE SHOOTS
- This week's data will show both whether the inventory rebuilding that was priced in over recent months is actually materialising and whether there are any other drivers of economic activity out there. The flash PMI in Europe and sentiment indicators will be particularly relevant in deciding on the latter issue, with consumer and income data out from both sides of the Atlantic providing an additional window on how domestic demand is shaping up.

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.

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.