Global Markets Weekly - 22 March 2010

• Falling volatility, narrowing spreads and new highs for equities.
  Markets remained in optimistic mood this past week , with the VIX Index of expected volatility falling further, the spread between corporate and government bond yields narrowing and the S&P reaching an 18-month high. The benchmark US equity index has now rebounded 10% from its early February low, led by financials, real estate and basic materials. Sterling also regained some ground against the dollar and euro.
• Policy support continues to underpin growth.
  In a further indication that policy-makers in advanced economies are willing to underpin growth, the US Federal Reserve (Fed) kept interest rates at emergency lows and repeated the phrase in its policy statement that rates were expected to stay there ‘for an extended period.’ The Bank of Japan (BoJ) also doubled a short-term lending facility to banks. However, tensions over Greece re-emerged, with Prime Minister George Papandreou threatening to turn to the IMF for emergency funding unless the European Union (EU) comes up with firm proposals of its own by the time of the EU summit on 25-26 March.
• The UK government borrowed 'only' £12.4 bn in February (still a whopping deficit).
  There was some good news in the UK, with the public-sector borrowing requirement coming in lower than expected at ‘only’ £12.4 bn in February and the unemployment rate falling slightly. Sterling strengthened on the back of the data, climbing to just shy of $1.54. Speculative short positions against sterling have come off a bit in a possible sign that some investors are already anticipating a further rebound in the currency. For the fiscal year 2009/10 as a whole, the public sector borrowing requirement may come in at £5-10 bn less than the £178 bn the government had predicted in December. We will know more after the Budget on 24th March. However, this would still be a whopping annual deficit, on a par with Greece, at around 12% of GDP.
• BoJ boost to banks is no "miracle cure" for deflation.
  The Japanese central bank decided to double a programme of three-month 0.1% loans to banks from 10 to 20 trillion yen ($220 bn). The BoJ measures were largely symbolic, however, with Japanese banks already having enough liquidity. The problem is their reluctance to lend. Indeed, BoJ Governor Shirakawa claimed that there was no "miracle" cure for deflation.
• US inflation data supported the Fed decision to keep rates low.
  The Fed’s decision to continue with its pledge to keep rates near zero for an extended period led investors to pare back their expectations for early rate increases. Indeed, the latest US inflation data also suggested that there is no need for early policy tightening. Headline inflation came in slightly lower than expected at 2.1% in February, down from 2.6% in January. Core inflation was only 1.3%. Despite this, one member of the Fed’s rate-setting committee did dissent. Thomas Hoenig warned that the continued pledge to keep rates at emergency lows could lead to financial imbalances and put the long-term stability of the economy and financial markets at risk.
• Emerging countries are facing rising inflation pressures.
  Inflation figures in the developed world contrast sharply with inflation developments in emerging markets , where commodities such as food are a more important component of the total consumption basket. For example, Indian consumer price inflation is currently running at 16% and wholesale price inflation rose to 10% in February. In response, India’s central bank unexpectedly raised interest rates on Friday, a month before its scheduled monetary policy meeting.

Indices, Interest rates and Inflation

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