Global Markets Weekly 18 October 2010

• New highs across a broad swathe of markets and assets, driven by QE2

  Markets hit new highs around the globe and across different asset classes in anticipation of further quantitative easing in the US (QE2). This expectation was clearly reinforced by the minutes of the latest meeting of the Federal Reserve (Fed), which said it "was prepared to provide additional accommodation if needed". The VIX index of equity volatility hit its low since April, with the S&P 500 gaining 1.0% for the week. While global markets on average are only back to April’s highs, emerging markets, which we have been recommending this year, are at their highest level since June 2008, before Lehman’s collapse. In commodities there were new highs in industrial metals, in corn and in our favoured counter, gold, which hit $1,376/oz. Bonds were more mixed, as some inflation concerns re-emerged for the longer term, but remained close to recent highs. We continue to forecast positive returns, especially from corporate bonds, which offer more attractive yields.

• Dollar decline prompts ‘currency wars’ with increasing risk of an escalation of policy disputes

  Compared with the coordinated international response to the financial crisis and recession, currency markets are now clearly revealing political fragmentation as countries pursue mutually contradictory policies to secure incompatible economic goals. While the prospect of QE2 from the Fed dominated the headlines, this is the tip of the iceberg as the last week has seen policy action, currency intervention or rumours of intervention from 25 central banks. The potential for both escalation into a full-blown trade crisis and unforeseen side-effects from ‘disorderly’ currency moves and uncoordinated policy responses add considerable risks to currency and other financial markets.

• By taking the initiative on policy tightening, some countries are demonstrating openness to a mutually beneficial compromise

  Singapore announced that is was widening the bands on its exchange rate regime and increasing the pace of appreciation, in order to allow a greater policy focus on controlling interest rates. Similar measures were also announced by Russia. Such policy flexibility and willingness to de-couple interest rates from the US point to the potential for a compromise that is mutually beneficial. By contrast, the US saw headline and core inflation of 1.1% and 0.8% respectively, indicating that it requires easier monetary policy. UK inflation, however, has remained stubbornly high at 3.1%, which may delay the Bank of England from joining the Fed in launching QE2, even though we continue to believe that the underlying trend, shown by the ex-tax inflation figure of 1.5%, indicates that further policy action will eventually be required.

• Company results beat expectations and M&A picks up

  With about 4% of companies having reported results, the quarterly earnings season has begun on a positive note. Some companies that are often seen as a bellwether such as aluminium producer Alcoa and chip producer Intel have beaten estimates by 66% and 3.5%, respectively. This was coupled with upbeat guidance for the rest of the year. A look into the detail highlights a telling story for both companies - a significant increase in demand from emerging countries such as China and Brazil. This was further highlighted by US freight company CSX, whose strong results were boosted by a big increase in car shipments, indicating a robust recovery in international trade. This highlights a key theme, low-growth developed market countries will see their companies rely much more on revenues generated in high-growth emerging economies, driving a surge in M&A in this area.

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