Welcome to Kit Juckes's Market Commentary blog. This page is updated regularly to cover events impacting the global financial and currency markets.

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When I started work in the summer of 1984, the yield on US 30-year government bonds was 12.75%, as then Fed Chairman Paul Volcker reigned in inflation and targeted money supply while President Reagan was engaged in an expensive arms race (ultimately helping to bring the Cold War to an end, but that’s another story). In broad terms, the yield on US government debt has been falling ever since – or at least, it was until recently. We saw a low at the end of 2008 that was just above 2.5%. But unless yields dip back this afternoon from 4.75% to under 4.71% (a small move, but a significant one), this will be the first time since I started work that the monthly close will be above its 100-month average. Now a 100-month average doesn’t have huge significance of itself, at least not to anyone other than a particular brand of market technician, but this is a line which was tested (but not broken) in the bear market of 1994 and again in 2000, 2006 and 2007. So if it does break now, that does at least ask one important question – has the long (27-year) downtrend in US bond yields come to an end? The economy can’t get any worse than it was a year ago. The level of interest rates can’t get any lower. And the supply of government debt is going to get bigger and bigger for a while. Even inflation, which is now trending down, probably can’t really fall significantly further. I don’t expect an explosion because rates aren’t going up, inflation isn’t going up and growth isn’t about to ‘take off’. But to answer my own question, I do think the lows in bond yields are behind us.

Why does this matter? For currency markets, it is important for one main reason – the dollar, like the bond yield, has been going down for most of my career. Even the pound, hardly the brightest star in the currency sky, is a good bit stronger than its flirtation with parity against the dollar in February 1985. USDJPY has fallen from 260 to today’s 93 level and the USDDEM level has fallen from 3.45 to 1.46 now. In today’s language, that’s the equivalent of EURUSD rising form 0.56 to the current level of 1.34. So, if this long, long decline in US yields is over, perhaps the dollar’s long decline is over too, and even if that is clearly not a reason around which to base short-term trading views, it does make me wonder whether the dollar could move closer to its longer-term ‘fair value’ level against the other majors, at least for a while. Or to put that another way, is it really appropriate that my morning cappuccino should continue to be cheaper in New York than Paris or Tokyo?

The euro has new woes to afflict it as the price of Greek debt slipped yesterday, renewing concerns about their funding, and Ireland’s Finance Ministry announced that the country’s banks’ capital shortfall is even bigger than expected (click here for the Irish Independent story). The expression ‘caught between a rock and hard place’ seems too benign. Ireland has done ‘all the right things’ by introducing austerity measures, but the recession has made the financial black hole deeper and darker. The Greek authorities are being pushed into adopting similar measures and must be quaking in their boots. And the Portuguese and Spanish governments are probably feeling a little queasy as they watch from the sidelines. The ECB can either fiddle, Nero-like, while the outer rim of Europe burns, or keep rates very low and preferably find imaginative ways of increasing demand for European governments’ debt. Either way, I can’t see too many reasons to want to own a euro.

Meanwhile, the start of the new fiscal year in Japan (tomorrow) may well see a renewed focus on foreign higher-yielding assets. I expect the Australian, Canadian and US bond markets to benefit. Just as I don’t expect a huge rise in bond yields and don’t expect interest rates to go up any time soon (in the US), I don’t expect a dramatic move weaker for the yen, but just as bond yields have troughed, so I think the yen has peaked.   

There’s no news in the UK. Opinion polls are steady, showing the Conservatives with a 7-point lead and most of the newspapers seem more obsessed with Wayne Rooney’s ankle and the miserable weather than with the economy. The pound is being helped by short-covering and by not being a euro.

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From November until, well, recently, the ‘Big Story’ in financial markets was the Greek financial crisis. Last week, as a support package was agreed and preparations were made for Greece to issue more debt, the focus appeared to be switching to the risk that higher bond yields in the US represented a buyers’ strike and, as such, a major threat to the economic recovery and the equity market rally. This week, with the month and quarter-ends ahead and the Easter break set to reduce liquidity, has seen another theme come to the fore – ‘risk on’.

It’s a bit surprising to see markets so indifferent to the rise in bond yields but this morning, we have all the currencies which traditionally do well in a risk-friendly world (Australian and Canadian dollars, a range of Asian currencies and even the pound) rallying, while the US dollar and Japanese yen are floundering. Asian central banks have been intervening to keep their currencies from appreciating too fast and that money will in turn be recycled back into global asset markets. Commodity prices are higher and at least so far, equity indices are up too.

So what is driving this improved sentiment? And more importantly, can it persist? My view is that more than anything else the driver is nothing more complicated than the weather. The start of 2010 saw economic data blighted by poor weather on both sides of the Atlantic and across plenty of other parts of the world. This might not have mattered so much were it not for the fact that the financial and investor community is completely divided in its opinion of where the global economy is headed. So those who think we can see a stuttering, uneven but ultimately forward-moving economic recovery have been scared by soft economic releases, while the bearish camp have found justification in the data and even ridiculed those who have blamed the softness on the weather (winter always comes at this time of year). Well, the data are improving. US consumer spending data saw a fifth consecutive monthly increase in February and looks set to continue growing, albeit slowly. The market is optimistic about the employment data for March as weekly unemployment claims fall. In Europe, the purchasing managers’ surveys are recovering, and in Asia the Chinese economy is still booming. And in the UK we have revised Q4 GDP data up – again – to 0.4% (a victory for the Goldman Sachs-led assault on the quality of the initial release), while Nationwide reports a jump in house prices in March (click here).

The data improvement must be placed in the context of the poor data which came before it, however. The clocks spring forward, daffodils and primroses fill the garden and equity markets make their seasonal rally. A real cynic will now conclude that it’s all nonsense and prepare to sell in May! I’m not sure I want to go that far because the asset rally is down to low policy rates, the absence of wage growth and a really strong recovery in profits. But I definitely don’t want to get over-excited about the strength of the recovery. We are going to get plenty more disappointing economic data before we are done. Re-capitalising the banking sector, getting household debt levels down and sorting out the fiscal mess that major industrialised nations find themselves in are all going to hold growth down. But near-term, optimism may get as overdone as the pessimism of winter. I’m looking for bond yields to edge a little higher and for the growth and risk-correlated currencies to thrive. Commodity prices too, after a lull, look set to push higher.

As an aside, the UK Q4 GDP data – as well as revising growth higher – saw a sharp downward revision to the current account deficit for the fourth quarter to just £1.7 billion (from £5.1 billion). The driver isn’t an improvement in exports but a surge in the UK’s investment income to £10.5 billion. The pound’s fall may not have boosted exports (yet) but it is helping the conversion back into sterling of profits earned overseas. That’s one major advantage the UK has over Ireland and Greece, courtesy of a floating exchange rate.

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The US March employment report is due on Friday afternoon (has no-one told the Labor Department that Londoners are supposed to be spending the day with their families?), and is the focus of the week’s attention. At a time when the yield on US government bonds is heading higher amid talk of ‘bond vigilantes’ and of bonds being the ‘canary in the mine’ warning that fiscal profligacy cannot continue, the data take on even more importance than usual.

The bearish view, which is always the one to start with, is that the rise in yields last week increases the risk of a double-dip for the economy and renewed weakness for the equity market. President Obama signed a health reform bill – committing to even more fiscal largesse – at the same time as the Federal Reserve’s purchases of mortgage-backed securities are about to come to an end. Then the Treasury auctioned $118billion in 2-, 5- and 7-year securities and yields spiked higher. That, so the argument goes, shows that investors are not interested in buying more and more debt at these yields, which will in turn mean that mortgage rates go higher and the housing market suffers further. Higher yields will slow growth and send the equity market into reverse. On the other hand (because economists are always two-handed), if we get strong economic data now it will look as though reluctance to buy more Treasuries reflects a growing appetite for riskier assets and growing optimism that perhaps, after all, economic recovery is taking root. The equity market may not fly higher against a backdrop of higher yields but it will not collapse either, and perhaps the rise in yields will not be so bad after all.

The employment data surely won’t resolve these issues. The February employment report was weak, largely because the US was as badly affected by the weather as the UK. The latest indications from weekly unemployment data point to a strong rebound and, while the consensus forecast is for a 200,000 improvement, it could be even stronger. However, by the time we have dissected the data to work out the weather distortion, we probably won’t be able to tell whether they are indicative of stronger growth ahead or not. My own position is relatively optimistic: the US economy will hit headwinds but as I have argued several times, there is some momentum to the labour market recovery and it will probably deliver employment gains more months than not from now onwards. What it won’t do is make much of a dent in the unemployment rate in 2010. So stronger employment is good but it is unlikely to bring Fed rate hikes closer. I still think rate hikes are highly unlikely until the autumn at the absolute earliest and could be delayed until 2011. With core CPI inflation set to fall below 1%, that surely means that the upside to bond yields is not all that great – I’m sure we will see 10-year yields spike above 4% at some point, but I doubt they will get as far as 4.25%.

All of this means that for me, the latest bond move is not indicative of doom and disaster for the economy, or the US dollar. It is a sign that we have seen the lows in bond yields and is maybe followed by a slower pace of gains for equity markets. But I see it as a dollar-positive development and a yen-weakening one.

As for the UK, little new news over the weekend, though the general election campaign is now set to get underway. Opinion polls indicate a slight shift away from labour after the budget. I think the pound will start to rise before the election itself, simply because the end of uncertainty and policy paralysis are closer. That said, with Easter just around the corner and no meaningful economic data due this week, clear trends are unlikely to emerge yet.

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Finally, the eurozone has reached agreement on a rescue package for Greece. I am sure we will get more details as the day progresses, but what we know so far is that assistance will come from the IMF as well as bilateral loans from EU states. In practise, what will happen (I think) is that a backstop loan facility of some €20-30 billion will be announced, with disbursements controlled by the EU and the IMF providing technical support. For Greece, I think this means three things. Firstly, support for the rollovers of their current debt. That, in turn will result in concerns about their creditworthiness fading (Latvia, who got IMF help in 2009, have seen the spread on their 5-year credit default swaps fall from 1,200bp to 365bp). Finally, the IMF's involvement will have major negative implications for growth in Greece because fiscal austerity will be forced. An IMF-led rescue is always, as far as I can see, 'tough love'. That, in turn, will send very slow shockwaves around Europe because, now that a precedent is set, any other European countries who fears they may need support in due course will know what the quid-pro-quo for that help would involve. I expect the pressure for tighter fiscal policy to be maintained across the smaller eurozone nations and I hope British policy-makers are paying attention. The FT article is well worth reading (click here).

In the US, another day, another bond auction, another rise in Treasury yields. Is this ‘buyer fatigue’ or further evidence that investors are moving away from safe havens and towards riskier assets because the economic outlook is improving? As long as the rise in yields is orderly and not dramatic, it won't upset equities and will support the dollar. That's the goldilocks scenario. If 10-year yields rise from 3.87% now to above 4.24%, I'll start to worry.

And in the UK, it's Friday so here are the latest John Lewis figures (click here). As is their wont, they are upbeat in line with the bounce in retail sales we saw yesterday. Markets of course have bigger fish to fry ahead of the election, but sometime between now and early May I expect to see the improving economic backdrop (or less dreadful backdrop, if you think 'improving' is too strong), start to be reflected in currency markets.

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The UK Budget was never going to give us detail on public sector spending reductions and it was always highly unlikely that there would be a massive give-away of the ‘windfall’ which came to the Chancellor as a result of last year’s public sector deficit coming in below forecast. So there wasn’t much to expect. In the event, there was a medley of small, politically-inspired measures to help green banking, wind-farms, first-time home buyers and the like. This was financed by taxing drink, cigarettes and the rich. No real surprises there. The press has responded along predictable party lines with the right-wing press focusing on the lack of attention to deficit reduction and the focus on taxing the rich, while Larry Elliott in the Guardian says it was sensible and unflashy – and planted doubt about electing Cameron.

The best analysis of the budget (in my opinion) is from Martin Wolf in the FT (click here). The disaster of the UK’s public finances may be a legacy of the credit crisis, recession and the need to bail-out a banking sector which was a larger part of the UK’s economy than in other economies, but the seeds of disaster are older. There’s a chart in Mr. Wolf’s piece showing revenue and spending as a share of GDP and, while the latest surge in spending is due to the recession, public sector spending as a share of GDP has been trending higher since 2000 while government tax receipts have been pretty flat over that period. This has allowed public sector employment to grow by 18% since Labour came to power, whereas private sector employment has increased by just 7%. Government spending on an annual basis has doubled while receipts have increased by only 72%. This profligacy during a decade of strong growth and low unemployment left the public purse empty when the crisis struck and from here on, the need for massive spending restraint is clear. The Budget saw forecasts of spending reductions and of falls in the deficit, but no detail of how this will be achieved was given. It would have been silly to expect detail, but the lack of it still leaves everyone (from ratings agencies to investors, employers and tax-payers) worried. The pound went down yesterday but is bouncing this morning while Gilt yields, facing weekly auctions in the next fiscal year and £187billion of bond sales to finance, rose. The size of the funding need was not a surprise but the sheer size of it – post-quantitative easing – is still scary.

Now that the Budget is out of the way, the focus moves to the election and the economic data. This morning’s data comes in the form of February’s retail sales figures which follow the soft January figures. The weather continues to distort numbers already made difficult to interpret because of changes made to the series by the statisticians, but retail sales rose by 2.1% after falling 3% in January. Annual growth in retail sales volumes (excluding petrol) are running at a very impressive 5.4%, which is what my excursions from Brook Street to Oxford Street have been suggesting. My conclusion is that the pound is closer to the bottom of its fall than the top and will probably stage some kind of recovery into the election. Interest rates are on hold, but Gilt yields could rise further as investor buyer-fatigue sets in. This is already being seen in the US where Treasury yields rise very sharply yesterday.

That rise in US yields, which takes 10-year Treasury yields above 3.8% for the first time since early January, was competing with the Greek crisis as the main focus of markets. The treasury sells 7-year Notes today so there’s more buying for investors to do, though perhaps we now have a sufficient concession. The question for me is at what point the rise in Treasury yields becomes a negative for the dollar (because of fears that the difficulty in funding the deficit will drive mortgage rates up and stop the economic recovery). For now, higher yields are likely to attract more foreign demand for Treasuries, and as long as 10-year yields are not too high (below 4.25%, say) the move is dollar-supportive. But this will not always be the case and bears watching. So, I am a dollar bull but a slightly more nervous one than I was at the start of the week.

Meanwhile, an announcement of IMF involvement in providing support for Greece seems a possibility today. But the sovereign debt crisis has spread beyond Greece after Portugal's credit rating was downgraded by Fitch and more concerns about EU finances in general are likely to continue to undermine the euro.

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The yield on US 10-year government debt moved above that of 10-year interest rate swaps for the first time yesterday, indicating that increased supply is having an impact on yields. The catalyst was lukewarm demand for the latest US debt offering of 2-year Notes, which will be followed up today with the sale of $42 billion of 5-year Notes. The move, which takes so-called swap spreads negative in the US as they have been in the UK since February, has been accompanied by a rally for the US dollar which is stronger today against JPY and EUR.  

Currency markets have been more sensitive to relative interest rate moves of late than at any time I can remember, so a relative rise in US yields is important. I’m not sure, however, that I am as impressed by a rise in bond yields which reflects the higher price being paid for increased debt issuance as I would be by rising swap rates, reflecting expectations of higher policy rates in the future. In the long run, the move in government bond yields below swap rates indicates that, post-quantitative easing, the Treasury has to pay up at least a little to fund the deficit. What that implies, in turn, is that when (if) economic recovery does gather momentum and bank demand for ‘safe’ government debt starts to be replaced by appetite to lend, we will likely see much more upward pressure on yields. This is both a threat to recovery (long term) and reason to wonder whether we have really seen the back of quantitative easing.  

For now though, the upward pressure on the dollar could not come at a worse time for the euro. Fitch has down graded Portugal’s credit rating this morning (to AA- with a negative outlook), and there remains a complete lack of consensus on what to do about providing support for Greece. The ‘flash’ purchasing manager indices for eurozone economies were released this morning, and the composite figure came in at a solid 55.5, their best since 2007. But in the world of currencies, nobody cares as sovereign debt concerns move back to the fore.  

In the UK it’s Budget Day: 12:30GMT will see the announcement. The leaks so far all point to a ‘sensible’ as opposed to a ‘giveaway’ budget. Mr Darling will focus on taxing bankers, smokers, drivers and drinkers, but he won’t make any major policy moves. My wish is that the focus should be on clear and credible plans to get public sector spending cuts in place, but that’s a wish rather than a forecast. As I have written before, it is clear from all the academic work on the subject that spending cuts are less likely to hurt the economy than tax increases, and it has always been very clear to me that a simple tax and benefits system is far more efficient than a complicated one. Irrespective of any political bias, these two factors should be drivers of how policy is executed. Expecting Mr Darling to do anything to simplify the system is, however, wishful thinking.

For the record, the Budget will probably not see a revision to growth forecasts in 2010 and 2011, despite the fact that the 2011 forecast at 3.25-3.75% is deemed implausible by every UK economist I know. The public sector net debt forecast can fall from £178 billion (in the pre-Budget report) to £163 billion after recent better data and should decline steadily from there to about £100 billion in 2012-2013. That takes it from just under 12% GDP in the current fiscal year to just over 6% GDP in two years’ time. But it is based on optimistic growth forecasts. As for Gilt sales, these will fall from £237.5 billion in the current fiscal year to just under £200 billion in 2010-2011. That’s an encouraging trend but in the absence of the £200 billion that have been bought by the Bank of England, there will still be upward pressure on yields (and downward pressure on swap spreads). As for the pound, I expect that ‘sensible’ will be applauded to a degree, but the net result of a ‘sensible’ Budget would be to push interest rate increases even further into the future and I don’t expect any major currency moves until closer to the election. I’ll provide a more complete reaction tomorrow. For now, the dollar goes higher, government bond yields are absorbing the swap spread move and edging up, and, if equity indices correct today as a result, that will be just another little speed bump on the path to higher levels.

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Yesterday morning started with concern that the global risk rally could be at least temporarily derailed after the Reserve Bank of India raised interest rates. But the US S&P index ended the day higher, in part because healthcare reform provided a boost to drug and technology shares. The global risk rally appears to be back on track, still supported by near-zero interest rates and gradually improving economic data. In then UK, the FTSE 100 index is making new highs for the year this morning, pushing towards 5,700, a level last seen in June 2008. Whoever wins the UK election, my personal view is that, underpinned by an inactive MPC, the FTSE will reach 6,000 this year.

The UK highlight today is the release of CPI data for March. The headline inflation rate fell back to 3%, with the ‘core’ rate back to 2.9%. Attention is focused on the data because of a perception that the MPC is becoming slightly more hawkish and concerned about inflation. Looking beyond today’s numbers, which show the inflation rate falling back from last month’s 3.5% peak, helpful base effects should see CPI inflation fall back below 2% in early 2011. My own view is that in an economy with wage growth below 1% and a shocking lack of credit creation, the drivers of inflation are imported prices and the tendency of a cash-strapped government to drive up prices of any service it controls, from transport to the provision of local services. This is an erosion of households’ real spending power, but not something that the MPC should do a lot about (other than to stop talking down the pound). If the government is a driver of inflation, the MPC can offset this by slowing private sector demand to the point where that drives prices lower, but it would be better if the public sector stopped above-inflation price increases. I don’t expect the MPC to hike rates any time soon. They will ‘keep their powder dry’ in terms of further quantitative easing, and if the data start to improve they may start stressing in public comments that current rate levels are extraordinary, but actually hiking will require much better economic data.

The outlook for rates is intriguing everywhere. The news headlines yesterday came form the CBI who published another downbeat UK economic forecast (click here). They forecast growth this year of just 1%, slower than most expect, and with the unemployment rate continuing to rise all year. And yet they still expect a Q3 rate hike. So many people share the view that it cannot be ignored, but surely if inflation is falling (as it will from here on), unemployment is rising and fiscal policy is being tightened, the case for increasing rates is pretty thin. And this is true not just of the UK but of the US and the eurozone as well.

In currency markets, the main event is still the wrangling over an aid package for Greece. This has gone on far too long. So far, we have been fortunate to avoid bad economic or fiscal news in Europe, but it would not take much to trigger another sharp euro sell-off form here.

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The best news so far is that Japan is off today for its spring equinox celebration – a reminder that for the next six months, the days are longer than the nights. There is, however, a lot going on in markets. The US Congress passed healthcare reform legislation which will be a major talking point for all Americans this week. In  Asia, India was the latest of the BRICs to tighten monetary policy on Friday, triggering a fall in gold prices and weakness in equities this morning. In Europe, Greece remains at the forefront of the political agenda, though a thumping defeat in regional elections for President Sarkozy is also noteworthy. And in the UK, the focus is on Wednesday’s budget, a bizarre event so close to an election. Opinion polls still point to neither major party gaining a majority but, with the latest talk being that Labour will offer the post of Chancellor to the LibDems in a coalition, Alastair Darling looks like he’s out of a job whatever happens.

The US healthcare reform elicits considerable emotion from every American I know. In Europe, we don’t really question whether state provision of healthcare is desirable, though we are very conscious of the cost and the inefficiency of the NHS. In the US, feelings are strong both about the need for more affordable healthcare and the potential cost. Here’s Paul Krugman on the subject in the New York Times – you can feel the partisan-ship in his piece (click here). But without wading into the politics of public sector provision of healthcare, only the US would be able to charge forwards with this legislation in the current fiscal climate. There’s even a story on Bloomberg this morning that points out that 2-year bonds sold by Warren Buffett’s Berkshire Hathaway yield slightly less than US Treasuries of similar maturities, with the headline ‘Obama pays more than Buffett as US risks AAA rating’. What strikes me however is that the yield on both US government and Berkshire Hathaway debt is under 1%. US 10-year year yields have been in a 3.5%-3.84% range since the start of the year. The US is able to delay tightening fiscal policy in a way that is simply not an option for either the eurozone or the UK. That’s what being the world’s biggest economy and major reserve currency means. And it’s the ability to keep both monetary and fiscal taps wide open without creating inflation that makes me optimistic about asset markets and, relatively-speaking, optimistic about economic growth.

The Indian rate hike (for the record, they hiked their repurchase rate from 4.75% to 5% against a backdrop of 9.9% inflation) seems to me a very sensible policy move – if anything, they are well behind the curve in tightening. Markets have responded the same way as they have every time the Chinese have made baby steps in the direction of tighter policy – selling off amidst fears of either asset bubbles bursting or of growth slowing. As my children might say ‘PerrrrLEASE!’ This has triggered a very small correction in equity markets and may provide a chance to buy gold.

In Europe, the French regional elections didn’t come as a surprise but are a reminder that any attempts at fiscal orthodoxy will always be resisted. Right across Europe, the change in mindset that will be required to take the fiscal medicine required by the current crisis is going to be politically very tough. And that’s not to mention the problems associated with trying to stand together on this issue. There is still no deal for Greece and the euro remains vulnerable.

In the UK, it’s Budget time on Wednesday. Better than expected borrowing data may tempt the Chancellor to give away this windfall. I think that would be political madness. The only way to play this budget is to do as little as possible and sound as sensible as possible. The public sector net borrowing requirement can now be forecast at below 12% GDP for this year and can be forecast to fall below 5% GDP in 2013/14. Good for gilts, and delaying higher rates even further. After the Budget is out of the way, the focus will still be on politics. But in the meantime, the data continue to suggest that January’s softness was indeed weather-related and the economy is improving.

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G5 near-zero rates continue to propel equity markets higher and help growth in the developing economies dramatically outstrip the G7. Meanwhile inflation is non-existent or at least very well behaved, so there is no pressure to tighten at the major central banks. Yesterday it was the turn of the US to release CPI data which showed headline inflation fall from 2.6% to 2.1%, and the core inflation rate (excluding food and energy) fall from 1.6% to 1.3%. The US Federal Reserve’s mandate is to ensure low and stable inflation within the context of full employment. The unemployment rate is at 9.7% and, looking at these CPI figures, merely increases my conviction that the first Fed hike comes later rather than sooner.

That doesn’t mean that I am pessimistic about how the US economic data is playing out. Barcap have responded to the better data recently by revising their 2010 growth forecast up to 3.6% at the same time as cutting their eurozone forecast to 1.1%. I’m not sure I want to go as far up as Barcap but the newsflow has been encouraging and the key point for me is that the economic bounce continues against a backdrop where monetary policy is in no way constrained. The Fed doesn’t have an inflation fight on its hands and so can continue to support growth with low rates. This, surely, is hugely helpful for the rest of the world and it flies straight in the face of all the fears that over-easy money would trigger a major pick-up in inflation.

The Fed may not change the Funds rate for a long time but rumours have re-surfaced about another increase in the discount rate in the next few weeks. The Fed increased the discount rate to 0.75% a month ago as they seek to normalise the structure of rates. The discount rate is supposed to be an emergency short-term borrowing rate and the spread between discount rate and Fed Funds rate was cut to an artificially low level during the credit crisis. So, normalisation makes sense and has no significance for market rates. However, if they do it again, the Fed will be signalling that the return to normality continues. That contrasts sharply with events in Europe where things are definitely not back to normal as the game of chicken between Greece and the EU over financial support continues. You can always rely on the Telegraph to jump on these stories and this morning’s column, ‘Markets spooked as Greek rescue plan crumbles’, (click here) is no exception. In currency markets, dollar out-performance relative to the euro (and for now, the pound) continues to be a core theme for me.

The UK has bits of news. The best of them is the headline in the FT that Darling is likely to use increased tax revenues to cut debt (click here). Yesterday’s public sector borrowing data were less awful than feared and that will result in a deficit that is lower than was previously expected. The Chancellor faces a choice next week: ‘spend’ this ‘windfall’ or use it to project a lower debt level in the future. There is only one ‘right’ answer. I may boil with rage if Darling uses a budget so close to an election to indulge in terrible economies for political ends. It looks as though common-sense may prevail. The latest John Lewis data (click here) show that sales are still booming. Either John Lewis is a lonely island of good retail news that has nothing to do with what happened elsewhere or next week’s UK retail sales data will be better than the flat number (excluding auto fuel) that economists are forecasting.

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Tuesday evening saw the US and Japanese central banks re-affirm their commitment to very low interest rates for a very long time. Up went equity indices and up went emerging market currencies. The main news yesterday was in the UK as the MPC sounded hawkish and the unemployment data surprised. Today we move back to Greece with ‘Greek worries return to unsettle investors’ in the FT this morning (click here). The underlying story is the one from Tuesday night – more and continued monetary reflation as central bankers remain unconcerned about inflation and happy to ease the effect of global economic re-balancing with the help of a devaluation of the G3 currencies relative to anyone they can persuade to revalue.

The UK news was good, up to a point. The total of people unemployed fell back 32,300, compared to market expectations of a 6,000 increase. The poor January data which had prompted concern about the state of the labour market were revised from a 23,500 increase in unemployment to a mere 5,300. On the surface this is good news. The Conservatives responded by saying that the dip is due to ‘hidden jobless’; and the FT headline, which focuses on the Q4 employment data, is entitled ‘Jobs figures show sector split’ (click here). Basically, any jobs that were being created in Q4 were in the NHS, while the private sector continued to lose jobs. With massive fiscal restraint just around the corner, the argument goes, the public sector will soon be shedding jobs and we will all be in despair again.

There is some truth in this, but the bottom line is that the rise in unemployment in this recession has been far less severe than expected. And so has the fall in consumer spending. And those two facts are related and relatively good news. Meanwhile, average earnings remained at very low levels, 0.9% on a 3-month average annual basis. The market had expected a bounce as last year’s City bonus collapse fell out of the annual measure. Maybe the City will boost next month’s figures and maybe the shift to staggering bonus payments over many years will keep wage growth down for a while longer. Excluding the madness of the City, the figure is at 1.4% and that’s made up of 4% in the public sector and 0.4% in the private sector. Avoiding any‘angry old man’ comments about that spread, I can only conclude that fiscal restraint will keep public sector wage growth down from now on and, as a result, I have not worried at all about a wage-driven rise in inflation. The headline inflation rates will remain scary for a while but, unless sterling falls continuously, inflation will fall back very sharply in 2011. On which note, the UK MPC minutes were released as well and were deemed slightly more hawkish than previously. There were no dissenters from the plan to halve the Bank of England’s asset purchase programme and some members were slightly more worried about inflation. Maybe that means the tendency of the Bank’s Governor to welcome sterling weakness will now fade.

The UK gets special mention because the net result of the upside economic surprises was some strength in the currency – notably against the euro which looks to be back in a downtrend as the ‘Greek relief trade’ runs out of steam. This morning, we have seen some marginally less awful-than-feared public sector borrowing data, which showed a net borrowing of £12.4 billion in February as tax increases, notably VAT, bounced back. In the fiscal year-to-date, the deficit is now £132 billion, compared to £66.5 billion a year ago. That’s awful, but it isn’t as awful as it might have been. I don’t think sterling can run too far in a world where there remains so much political uncertainty and where the data really don’t argue for any upward pressure on interest rates. Those countries without our levels of leverage and without our fiscal burden, all of whom are outside the G5 economies, still look much better.

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You can't fault central bankers' commitment to giving recovery a chance. The Fed and the Bank of Japan (BoJ) have made their commitment to easy money clear again overnight and equity markets are moving higher. As the Irish – and the Guinness salesmen – head for Cheltenham, we can applaud the asset reflation, if nothing else.

The US Federal Reserve left rates unchanged last night, made it clear in the wording of their statement that they won't raise rates for a long time, and made a few upbeat comments about the labour market improving. The consensus of Wall Street economists is for the first hike to come in the third quarter, and that seems a stretch from here. At the current pace of word-change in Fed policy statements, Q3 2011 seems more realistic.

The BoJ can't cut rates and can't indicate they will stay low for longer than expected because nobody thinks they will ever increase them. But in yielding to very public political pressure from the Government to expand their lending programme, they have done about as much as they can to undermine the currency. Normally, a central bank that shows it can be bullied by politicians makes everyone worry about inflation. The BoJ should be so lucky. Further policy easing would have been helpful over a decade ago and with Japan mired in deflation, a bit of 'inflation-fear' would be welcome. Still, as the BoJ gets political, there are fewer reasons to own the yen – and more to sell it if you can find any currency to buy on the other side. The Canadian dollar stands out, and most of the emerging market world is preferable.

Today, apart from celebrating St Patrick's Day, the focus may be back on the UK. We have MPC minutes – a chance to see how dovish the UK's central bankers still are – and unemployment data. UK unemployment surprised everyone by falling for two months in a row at the end of last year. January undid the good work – and more – so normal service is resumed. The expectation is for a 6,000 increase in unemployment. The Bank of England warned this week that if demand remains weak, unemployment may remain high, holding back demand. That is, of course, true but silly. If there's no recovery there won't be much growth. The story of 2009 was that unemployment remained lower than expected through the recession. The corollary will be weak employment in the private sector in the early stages of recovery and job shedding across the public sector for some time to come. How that plays out today I don't know but these figures, along with the public sector borrowing data tomorrow, will be critical for sentiment surrounding the pound and in determining whether or not we see another lurch lower before the election.

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“If China decides to stop purchases of government bonds, then we have a problem.” That’s a quote from Michael Woolfolk at BNY Mellon, commenting on the third consecutive month when China has reduced its holdings of US Treasuries. With Congress urging Obama to pressure Beijing on the need for an renminbi revaluation, and the Chinese retaliating by saying their trade surplus is not caused by the value of the currency, US/Chinese relations remain under the spotlight.

The US and China have a complex and fragile relationship. The US relies on China to finance its budget deficit by buying its debt (they own $889billion of Treasuries) but that’s just the mirror-image of China’s reliance on the US as a market for its exports (and as a source of private sector capital investment into China, for that matter). Within that context, I am personally rather unconvinced about what I can learn from the monthly data on Chinese purchases of US Treasuries. The amount of dollars the Chinese accumulate in any month is a function of the trade and investment flows between the two. If the USDRMB rate were allowed to float freely, the Chinese would not accumulate dollars but would see their currency appreciate. Because they don’t let that happen, they get dollars and have to do something with them. At the moment, for three months in a row, they are not using them to buy Treasuries. But what does that really tell me? The yield on Treasuries varies from 0.95% for 2-year debt to 4.64% for 30-year debt. Yields are lower than they were at the end of 2009. So, China is accumulating dollars, the US Treasury is selling debt, the Chinese are not buying it, and the yield on the debt is going down.

I don’t know why the Chinese are not buying Treasuries. But what I do know is that despite the absence of the Chinese, someone is buying Treasuries – and doesn’t seem to require particularly attractive yields to persuade them to do so. My own take on this is that the buyer is mostly domestic and mostly from the banking sector. Banks are making fewer ‘risky’ loans and are buying more government debt. As long as the yield curve is steep, they can pick up a lot of yield in borrowing short-dated money and buying longer-dated bonds. And as long as the Federal Reserve is on hold, this strategy will help repair balance sheets and generate huge profits.

At the moment my assumption is that if/when yields do rise, the Chinese will re-cycle their reserves into Treasuries. But if they don’t, what then? For the Chinese the choice is simple – either buy other dollar assets with their reserves or allow their currency to rise. For the US, yields have to rise enough to suck in other buyers. But what we are learning at the moment is that with rates at these levels and other asset markets being reflated by the Fed’s policies, there are plenty of buyers of Treasuries without the Chinese.

What does all this mean for the dollar? I am not worried about a major sell-off in Treasuries (I am slightly more worried about the UK Gilt market because nobody has a fixed exchange rate link that forces them to buy gilts, but even so I think the UK banking system can continue to soak up Gilt sales even if yields do rise relative to US ones). So what we have is a situation where yields stay down, China accumulates dollars and the US authorities continue to pressure the Chinese to revalue. All this is negative for the dollar – and forces more and more investment flows out of the US (squeezed out by the re-cycled Chinese reserves into other assets), into emerging market economies. So it maintains the upward march of ‘risk ‘ assets – equities, emerging market and corporate debt – and the under-performance of the lowest-yielding currencies like USD, JPY, EUR and GBP against higher-yielding ones. Including, as of recently, the Canadian dollar, whose 2-year rates are now above the UK’s.

As for today, the US FOMC meeting this evening has the chance to make changes to the wording surrounding interest rates. There is no chance of a rate change but there is a desire to make tiny changes to signal a tortoise-like move towards normality. Any change is probably dollar-positive. In Japan, the BoJ makes a policy announcement overnight with some further stimulus in the form of bond-buying expected. In the UK, we have opinion polls favouring the Conservatives and criticism of the deficit-reduction plans from the European Union. The pound slipped on the latter news and is bouncing on the polls, as the weight of GBP short-sellers triggers a correction.

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The US moves clocks forward today in what strikes me as a thoroughly mis-guided attempt to declare winter over. I’ve seen enough snowstorms on the East Coast to know that spring just isn’t here yet, though like everyone else I welcome the longer evenings. Meanwhile in the world of foreign exchange there really isn’t anything much to like about most of the major currencies. Rather, it remains a closely-fought contest as to which is the least attractive.

The likely appointment of San Francisco Fed President Janet Yellen as vice-Chair of the Federal Reserve Board is being touted as evidence that President Obama would like as dovish a central bank as possible. That’s just the latest in a long line of moves which suggest that the US is favourably disposed to seeing a shift in its economy towards more exports, and less reliance on the enthusiasm of its consumers to spend borrowed money. Hardly a recipe for a strong dollar, though it is a recipe for continued pressure on China to revalue the renminbi, which in turn prompts annoyance in Beijing of the kind expressed by Wen Jiabo in today’s press (click here). With soft, weather-hit industrial production data due today and the FOMC meeting tomorrow unlikely to change the language in its policy statement (i.e., they are keeping the monetary tap wide open for as long as it takes), there is nothing intrinsically attractive about the dollar.

That’s fine, but there’s not a lot to like about the euro either. French voters have, according to exit polls from regional elections, shifted left in a blow to President Sarkozy. That doesn’t suggest the need for fiscal restraint is winning hearts and minds. I’m sure that a safety-net for Greece will be announced soon, but concern about what Greek fiscal restraint will do to growth will not go away, and there is a growing focus on the need for more co-ordinated fiscal policy across Europe. With eurozone growth unlikely to come in above 1.5% this year, the ECB is on perma-hold and the euro has few attractions. The yen’s only merits are that with rates at zero, cuts elsewhere have caused convergence on Japanese levels, and with no need for external financing, Japan doesn’t really have to worry about its public sector debt in the way the UK does. But if the global crisis is over and rates cannot be cut anywhere else, there aren’t really any defensive reasons to own the yen. So it remains at current levels until rates start to move higher elsewhere, and then it is likely to weaken. But that could be some time away.

As for sterling, this week does not seem like a good one to get all bullish. Opinion polls continue to point at a hung parliament and the Conservatives are struggling to win over the electorate with a ‘tough love’ platform of getting the public sector deficit down quickly. Last week’s trade data has prompted a widespread sense that the UK is not benefiting from the weakness of the pound and those who argue that timelags and the weather may explain that are easily ignored. This week we see February public sector borrowing data (January’s were horrific) as well as unemployment (after a shock jump in January). The latest Bank of England Quarterly Bulletin argues that if growth in demand is weak, we could be in for higher unemployment which seems pretty obvious but is making headlines (click here). In short, everyone hates the pound – and a lot of people are ‘short’ of it. But ahead of the elections it will need a clear catalyst to trigger a bounce.

So, I find it easy not to like another of the major currencies. That inevitably leaves me preferring currencies like the Canadian dollar, where market rates are edging higher and where last week’s employment report was very upbeat. It also makes me look favourably at equity markets which benefit from the softness of rates and which are, after all, indices made up of the value of real companies which really make real things! The only question there is whether the US S&P index needs a ‘run-up’ to break through the 1,150 level that remains the major focus for both bulls and bears. Futures are at 1,142 this morning.

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Markets remain quiet. The US S&P index popped its head above the 1,150 level last night but a 1,150.24 close hardly decides the battle. The euro is on a bit of a charge this morning as the ‘risk on’ trade undermines the US dollar and market interest rates are generally moving higher. There is talk of a Chinese rate hike happening soon (raising the 1-year deposit rate from 2.25% to 2.52%) and talk of easier policy in Japan at next week’s BoJ meeting. The main economic indicator to be released today will be US February retail sales, though it will be very hard to interpret the data. The employment report tells us that 1 million people missed work during the month as a result of the bad weather. Did they sit at home buying things from Amazon, struggle to the local mall or go tobogganing with the children? The risk is that we see retail sales fall but the market risk is that we are priced for soft data and any reason to see signs of underlying strength will elicit a reaction. In the UK, the John Lewis sales data were released, booming as ever (click here), the latest polls show the Conservative lead at just 3% in the Sun, but at 13% in an Angus Reid poll for ‘Political betting’ (click here). The pound has benefited form the Angus Reid poll, if only because we are now priced for a hung parliament.

The US flow of funds data for the fourth quarter were released last night. They make dry reading but for those who want to, click here. There are a couple of interesting points: the first is that despite a sixth consecutive quarterly decline in household debt and a third decline in corporate debt levels, overall US non-financial debt levels are still going up – thanks to very strong borrowing by the public sector. Overall, non-financial debt has reached an eye-popping $34.7 trillion. Public sector debt has reached $10.2 trillion. The other interesting fact (to me, anyway) is that corporate profits have gone back above their peak levels. You might have thought that the worst recession in a lifetime would have given corporate profits a really big squeeze but that isn’t what has happened. The share of profits in GDP is going up again. Low labour costs, massive labour force reduction, a cut in investment spending and low rates are all working their magic. I’m not sure this would get much approval from social economists who probably conclude the free market is failing, but it does encourage me in a view that a weak recovery combined with super-easy money can be very good for asset markets in general including equities.

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Financial markets are finely poised. Equity bears hope/fear that the 1,150 area in the US S&P index is a ‘double-top’, with failure to break it followed by a major correction. Bulls are hoping for a break to the upside. And the close last night was at 1,145. Bond markets are range-bound with policy rates on hold across the G7 economies and soft growth and inflation balancing increased supply. And currency markets, which are correlating incredibly well with interest rates, are looking for a catalyst for their next move. Meanwhile, the non-G7 currencies and markets in general are thriving from the easy G7 policies and the transfer of economic power and wealth from the old emerged economies to the newly dominant ones. My bets, unchanged of late, are that equities break out to the upside, that G7 currencies fall further against the rest but the euro is the weakest of the G7. And bond yields are in a range until growth gets some traction when they will move higher. That will not happen imminently, but is likely to happen in the UK (in yields as opposed to policy rates) before it happens elsewhere.

There is a limited economic calendar today. The Bank of England releases its inflation attitudes survey, the US releases trade data for January and the ECB releases its monthly report. None of these will move markets on their own. The one piece of major data that comes out, however, is the US flow of funds report this evening. This will give us an update on the trends in US debt and bank lending. Until last year, it simply amazed, as the US bank lending’s share of GDP rose inexorably higher as the total debt level of the US consumer and business sectors reached ever higher levels. The total lending of US commercial banks went from a little over $2trillion in 1994 to over $7trillion at the end of 2008. It’s now gone into reverse, though that is mirrored by a move in the opposite direction in public sector borrowing.

The implications of the surge in public sector debt on the one hand and the downshift in private sector borrowing on the other will be the dominant economic forces within the major economies for the next several years. At a global level, they help drive the biggest theme of all which is global economic re-balancing. We are going to have to sell our debts to investors overseas and have a huge incentive to devalue those debts by allowing/encouraging our currencies to fall. The alternatives for us are either massive fiscal restraint and economic pain or domestic inflation, and I cannot see how that is generated in the absence of any real wage growth.

I was reading a report yesterday, written a year ago by the Bank Credit Analyst (BCA), about the ‘final inning’ of the debt super-cycle. The BCA invented the term ‘debt super-cycle’ and it captures neatly the way the US has responded to recent recessions by cutting real rates and creating growth with the help of even more debt. Here’s a quote from the report: ‘At some point, investors will probably rebel against what they see as unsustainable and dangerous monetary and fiscal stances. Whether it is fears of dramatically higher inflation and/or a collapsing dollar, risk premia on US assets could soar dramatically. Rioting markets will force policymakers into a drastic tightening, sending an already weak economy into a tailspin’. Having accurately predicted the credit crunch and the monetary and fiscal response, the BCA predicted a market reaction which hasn’t happened (in the US, anyway). The fear that quantitative easing and fiscal largesse would scare markets to the point of causing a crisis has not materialised, in large part because it has not caused inflationary pressures to build – yet. The ‘bond vigilantes’ haven’t done their job. The assumption that the debt super-cycle is now coming to an end as we all retrench in the wake of the credit crisis may not be true. Personally, I suspect that with rates even lower and with banks under the control of governments, there may be another leg to this super-cycle as public sector debt explodes. In other words, there is another down leg to the economic cycle, but it may be years rather than months away.

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Three countries have released trade data in the last twenty-four hours – the UK, Germany and China. The US releases trade data tomorrow. The underlying story is incredibly simple: falling exports in Germany and the UK, and booming exports in China. UK exports fell 2% in the year to January. German exports are up a mere 2.4% in the year to January and down 6.3% on the month. Meanwhile in China, exports grew 42.5%. I cannot think of a simpler or starker indication of how fast the centre of global economic gravity is shifting away from the G7 economies and to the new growth centres than this. And it makes me even more depressed about the outlook. Here’s another statistic: a base case assumption, on current trajectories, of public sector debt levels in 10 years’ time (collated by Deutsche Bank) comes out at 133% GDP for the developed economies (us) and a mere 35% GDP for the emerging economies (them).

At a practical level, the markets’ response to the most recent data is to sell the euro and the pound and to speculate further on Chinese monetary tightening. Some of the initial reaction may be a little overdone because the trade data’s softness is probably weather-related (food exports fell, for example, presumably because farms were blanketed in snow, while imports were less affected since by definition they come from somewhere else!). But the underlying trends are stark and are here to stay. The principle hope for global economic recovery lies in the prospect of the emerging economy boom continuing on the back of G7 easy money, while the G7 economies stabilise and grow slowly as our banking systems are brought back to life. This will continue to support currencies in resource-rich economies which export to the resource-hungry fast-growing economies in Latin America and Asia. And despite some recent loss of momentum, I expect this to go on supporting commodity prices, particularly denominated in G5 currency terms (i.e., in dollars, euros, yen or sterling).  

Other than the shock from the trade numbers, it has been a quiet week for news. Gordon Brown is speaking as I write and has reminded us that he has taken tough decisions four times so far (10 minutes into his speech). He has announced that the Budget will be in two weeks time, on 24th March, which is generally perceived as implying a 6th May election date. How having a budget that close to an election at a time when there is no room for fiscal largesse can be good for the Labour party’s chances of winning the election escapes me. At least the timetable is getting clearer, however, and the massive cloud of uncertainty over the UK will lift before too long. We will also get UK industrial output data for January in a while. I will update on that tomorrow. In the US, dovish speeches from central bank governors yesterday helped the equity market continue to probe to the upside and the S&P 1,150 level is clearly proving to be a magnet. I still expect it to be broken and for that to be followed by something of an acceleration higher. In currencies, G7 currency weakness relative to non-G7 currencies should continue. EURUSD appears set to break lower before too long, but at the moment it’s just about holding above 1.35. Sterling competes for now with the euro as the most unattractive of the major currencies. It’s a close-run contest, though I think sterling is less ugly than the euro on any timeframe that gets past the election.

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A quiet post-payroll Monday was notable for the lack of follow-through by the US interest rate market (yields dipped back slightly for no discernible reason), and by sterling traded pathetically and everyone is trying to explain it this morning. Equity indices hardly moved and most of the commentary has been about how low the volumes were. The bigger question this morning is whether the softness of bond yields, on the trading day following a strong US employment report, has any significance. An article was posted on the FT’s website yesterday evening that asked whether shorting US Treasuries could be a mistake (click here) which reflects the uncertainty people are beginning to feel on this subject.

US ‘official’ interest rates are highly unlikely to go up this year. Inflation remains less of a near-term threat than deflation, so it should not be surprising that bond yields are not very high. The opposite side of that coin is that there is huge supply that needs to be bought by someone and might be seen as likely to send yields higher, while the policies of the US – currency debasement and massive monetary stimulus – might make at least some people worry about inflationary risks in the long term.

I’ve taken a pretty simple approach to looking at Treasury yields. There is an inverse historical relationship between the Fed Funds rate (short-term official rates) and the slope of the yield curve. In other words, the lower the level of Fed Funds, the steeper the curve and the wider the gap between overnight and term money rates. That is pretty intuitive. And so, the US yield curve is now steeper than it was in the past because the Fed Funds rate is at an all-time low. Homing in on the front end of the curve, the gap between Fed Funds and 2-year yields, during those periods when Fed Funds are at a cyclical trough, has ranged (over the last 25 years) between 180bp and 30bp. That 30bp spread was seen back when rates troughed at 6% in 1986 and at 4.75% in late 1998 after the Russian default and LTCM crisis. Intuitively, the lower the trough in rates, the wider the gap might be expected to be. On that basis the current 60bp difference between 2-year yields and Fed Funds is already extremely tight and reflects the belief that rates are down here for a long time. Currently, it seems to me therefore that yields in the US remain range-bound. I can’t see how the 2-year rate can really close in much further than it already has on the Fed Funds rate but, with 2-10s at a record level of steepness, I can’t see long-dated yields rising much from here. So both the level and slope of the curve appear range-bound and unduly sensitive to the gyrations of the monthly economic data. This week there is a heavy calendar of Treasury supply ($40bn of 3-year notes today) but no more major economic releases until Friday’s retail sales figures. I still expect on balance some modest upward pressure on yields. And that, in turn, means I expect to continue to see the US dollar maintain its current uptrend.

Meanwhile, I expect the equity market to go on slowly squeezing the most committed bears who are looking at the previous peak in the S&P index (at 1,150) as a potential ‘double top’ from where Armageddon is unleashed. This level could see a lot of nervousness form both bears and bulls but ultimately, with rates going nowhere, the weight of money looking for better returns will probably see a further move higher.

The UK has seen a series of secondary economic releases overnight and this morning as well as more opinion polls. The latest poll results (click here) still point to a hung parliament. The RICS survey still shows a majority of surveyors reporting higher house prices but a significantly lower majority. The BRC retail sales monitor (click here) by contrast reported upbeat sales but was awash with caveats. And the trade data for February were awful (there really isn’t another word for it, the deficit widening to £8bn as exports fell). Sterling remains close to last week’s lows.

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It is possible to scoff at the importance that markets place on the first major economic release of each month – the US employment report – but it is not usually wise to ignore it. Last Friday saw the release of February’s jobs report which appeared to indicate that the underlying improvement in the US jobs market continues. ‘Appeared to indicate’ because the data were heavily distorted by a blizzard during the survey week. Nonetheless, employment fell by ‘only’ 36,000 and the unemployment rate remained at 9.7%. Adjusting for the fact that a million people missed work as a result of the weather (compared to a seasonal norm of 290,000) it would seem things are getting better.

On 4th December, prior to the release of the November US jobs report, EURUSD was trading just under 1.51, very close to its high for the year. A strong report set the scene for a decline to 1.43 before the release of the next month’s data. On 8th January, however, the data were slightly weak and EURUSD moved back up until fears about Greece took over. Last month, the data were inconclusive but I think Friday’s data could have the same kind of effect as the report in early December – sending US bond yields modestly higher, the dollar up, and continuing to support the positive tone in equity markets. This ought to be the dominant theme in the month, once the focus shifts away from Greece’s fiscal woes.

People are forced to pay attention to every piece of significant economic news because the debate about whether the economic recovery is anaemic or in outright danger of being reversed continues to rage so fiercely. My colours are firmly tied to the ‘anaemic but not double-dip’ mast, and these data support that view. Once the weather stops distorting the data we should see a string of positive payroll reports. And for now that will be good for the US dollar. As an aside, here is a very interesting paper for monetary policy geeks (and a very boring one for anyone else, so feel free to ignore it!) looking at US monetary conditions from a variety of angles and concluding that they remain, at this point, slightly restrictive (click here). It is the kind of paper which brings home the risk that policy rates stay at current levels for a very long time.

In the UK we have seen more opinion polls which, while they suggest that the most recent trend is for the Conservatives to be moving ahead again, a hung Parliament is still the most likely outcome. A BPIX poll in the Mail, however, suggests Conservatives are doing better in marginal seats, something every ‘expert’ keeps on telling me. Here is a link to the UKPollingReport website which tracks the polls (click here). My view is still that many people will simply not vote, that the polls probably understate the eventual swing away from Labour, and that what really matters is how the economy comes out from recession. Meanwhile, frustration at that the Chancellor’s reluctance to detail his deficit-cutting plans is growing (click here) and I wonder if all this means the Prime Minister will now be tempted to call the election in April, rather than risk a reversal in the poll trend. There is not a lot of economic data to wait for in the UK this week, though the strong PMI data at the start of last week may translate into solid gains for industrial production (released on Thursday). And the weekend saw the John Lewis sales data release (click here) which suggests less awful weather is getting people back into the shops.

There isn’t really any new news on Greece. Their austerity package has been proposed and just needs to be enacted. The rest of Europe is trying to rally round. The next test will come as they raise more money in the bond market through the next couple of months. Greek CDS spreads have probably peaked but, as with an earthquake, strong aftershocks are to be expected. And the legacy – increased urgency to tackle Europe’s fiscal deficits – does mean that the ECB is on hold and if I had to own government bonds, German Bunds would remain my investment of choice.

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It is a painfully quiet day for financial markets ahead of the US employment report this afternoon. Yesterday saw the ECB and MPC do absolutely nothing with policy which has prompted very little reaction. Equity markets are closing in on their best levels of the year and therefore their best levels since the back end of 2008 when they were collapsing as the credit crisis gathered strength. There is going to be a furious debate in the coming weeks about whether this means the bear market is behind us, or whether the next leg is just about to begin. Robert Prechter of Elliott Wave International captures the bearish argument really well from a technical perspective when he says he expects an ‘echo’ of the early January peak to be seen before we set off on the next downleg, with a sharp fall in equities and further significant gains for the dollar.

I have never really been a fan of people who base analysis on chart patterns, but Prechter has a good track record and a huge following. The ‘fundamental’ arguments for this move to run out of steam are well known. A temporary reprieve for the global economy has been achieved courtesy of massive fiscal easing; and asset markets have magnified the effect in equity and other prices as a result of the central banks’ monetary reflation. But if you believe the global economy will run out of steam as easy fiscal policies are replaced by retrenchment, and if you think that pumping more and more money into the financial system is like pushing on a piece of string and won’t have much more impact, then it is easy to side with the bears.

The reasons to expect an anaemic economic recovery are too powerful to argue with. The debate is about what ‘anaemic’ means in a world where a typical rebound is much stronger than what we are seeing now or than any forecast I have seen anticipates. That is to say, the UK managing a growth rate averaging a little above 2% in 2010/2011 would be very weak indeed relative to the past, but pretty respectable relative to what is being talked about in City pubs. My expectation for now is that, with central bankers still keeping a very dovish bias to policy – rates nailed to the floor and only tip-toeing away from further policy measures, those of a bearish disposition are going to be made to sweat. So Mr. Prechter’s ‘echo’ of the previous high could well be replaced by a break, taking the FTSE back through 6,000 and grinding on higher as investors are dragged reluctantly back in.

As for today. So far, protests against Greek austerity seem quite modest but I still don’t like the euro and still expect tightening fiscal policy in Europe to be very hard work. In Canada, a very ambitious plan to eradicate the deficit over the next five years was announced yesterday. Canada has a minority government so this is an interesting test-case for the rest of us to watch, and if their government can gain support from its coalition partners, the Canadian dollar may well be the pick of the G7 currencies in the second quarter of 2010. There is fresh talk of pressure on the Bank of Japan to ease monetary policy further, and more resistance in China to a renminbi revaluation. As for the US payroll data, estimates look for the blizzard that hit the US during the survey week to reduce employment by 100,000-125,000. Excluding that, the underlying trend is for 50,000 jobs to be added so the consensus looks for a fall in employment of 50,000-75,000. But there is massive uncertainty about the actual extent of the impact from the weather. I suspect that a ‘strong’ figure will elicit a bigger reaction, if only because we won’t be able to blame that on the weather. But if markets were ‘sensible’ they would ignore this release completely. There is, of course, no chance of that happening.

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The Bloomberg news agency surveyed 45 UK economists for their views on the MPC policy decision today and 52 for the ECB rate decision. In neither survey was there a single dissenter from the consensus view that the UK will leave rates at 0.5% with the asset purchase programme at £200bn, while the ECB leaves rates at 1%. Today’s meetings ought to be non-events, but I can’t get rid of the butterflies in my stomach!

In the UK, stronger economic survey data are one factor behind a 10bp jump in 5-year interest rates this week, a move which looks like a reversal of some kind. If we do get through the M PC meeting without any surprises, the pound will likely rally and Gilt yields will probably edge somewhat higher. I expect (like everyone else) no change and the shortest policy statement the MPC can come up with. There is no doubt, however, that the MPC faces a simple choice – do nothing or increase the size of the asset purchase programme to, say, £225bn. That would undermine the currency and boost the Gilt market. It may be unlikely, but it clearly is not impossible. I don’t like days with binary outcomes like this and will update you tomorrow. Whatever happens, however, I think today’s decision does have the capacity to establish the trend for the next few weeks.

The ECB meeting’s focus comes in the press conference at 13:30 GMT when Jean-Claude Trichet will be quizzed about Greece and about the pace of removal of exceptional policy measures. There really is no chance of a move in the official policy rate. The ECB council is a consensus-seeking group of 22 people from 16 different countries in Europe which, to my mind, makes it about as nimble as an oil tanker. So while the ECB may eventually have to accept that the Greek debacle affects the pace at which exceptional policy measures can be reversed, I don’t expect any such announcement to come today. Instead, the ECB may sound slightly hawkish relative to expectations. Will that continue to help the euro recover some lost ground? I have been looking for a bounce this week and EURUSD reached 1.3740 last night. I am inclined to think that may be all we get. With a banner heading in the FT reading ‘Greece prepared to seek IMF aid’ it may be that all the good news on Greece is now ‘in’ (click here). And tomorrow’s civil service union strike appears to be spreading, so there will be plenty of adverse headlines.

The US sees a range of second-division news today ahead of the payroll report tomorrow. Fed policy is helping to drive emerging market assets higher but a strong yen is causing concern for Japanese stocks and there is a lot of talk of a further rate hike in China which is causing some jitters. These are minor road-bumps in the way of the move to higher equity and commodity prices but I don’t think they will alter the trend, unless tomorrow’s data provide a major surprise.

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I went to Geneva yesterday, partly (though not only) to check that Starbucks still charge more than twice as much for a tall latte in Switzerland as they do in London. The weather was wonderful, the people charming and the town was very quiet. People continue to report improving global economic conditions but they remain very wary about how long that can last – with worries about unemployment and bank lending still right at the forefront of those concerns.

Greece remains the ‘story du jour’. Prime Minister George Papandreou announced an additional €4.8bn in deficit cuts including higher taxes on tobacco and alcohol, as well as cutting civil servants’ holiday pay. The credit market has responded by taking the cost of protection against Greek default down and a few people have sent me charts that suggest Greek CDS tightening correlates with the EURUSD rate rising. Since the FT reports this morning that hedge funds have been increasing their bets against the euro (click here), the case for thinking a euro recovery (temporary or otherwise) might be on the cards is pretty clear. So far that hasn’t been seen to any great degree.

I still think there is a short-term risk of a euro bounce. Less fear surrounding Greece translates to increased risk appetite, higher equity prices and (usually) a weaker dollar. Concern about a soft employment report on Friday (weather-related or not) can cap US yields, while the ECB is unlikely to adopt a more dovish tone at tomorrow’s policy meeting (it’s just not their style). However, once the European fiscal genie has been let out of the bottle, it can’t really be put back in. Greek default can be avoided but the ECB has gone from the front of the queue to raise rates to the back. And both the need to address European deficits and the challenges that doing so will pose are exposed. In Europe everywhere, as in Greece, it is not the ability of governments to propose public sector pay restraint which is the problem – it is their inability to consistently pass those policies into law. And what that means, is that the euro is no longer in a position to benefit from periods of dollar weakness – which is how the world looks today, with USDJPY lower and most emerging market currencies trending higher.

If you take the euro out of the equation, what we are seeing at the moment is a combination of low rates and improving (underlying) economic conditions. Even in the UK – nobody’s favourite economy – this morning’s list of data includes a bounce in consumer confidence to 80 from 73, and in the PMI services index to 58.4 from 54.5. But at 2.95%, 5-year sterling swap rates are barely above their lows for the last year – and the debate about whether more Bank of England asset purchases are needed will rage on.

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The headlines are dominated by the assault on GBP which I wrote about as it happened yesterday (click here). Sterling fell very sharply from 10am until noon and hasn't moved that much since. A single, large sell order triggered the move and played to fears about politics and the difficulty of getting to grips with the budget deficit.

I'm not sure that yesterday's move is the start of a crisis – the 'crisis' may be nearer its end than its start. However, there are no obvious catalysts for a rebound and consolidation is more likely than bounce. Gilt yields though look set to rise further from here.

Outside the UK, manufacturing data everywhere remained reasonably positive, even if China's purchasing manager's survey fell back. And in the US, January consumption data were surprisingly robust. Overnight, the Reserve Bank of Australia (RBA) raised rates by 25bp to 4%.

Notwithstanding the general anxiety that is felt about the sustainability of economic recovery, reflation remains the backdrop for markets. First quarter growth data will be affected by weather in Europe and the US but are still indicating growth. Central banks are keeping rates anchored and only timidly winding down alternative policy measures. The Greek financial crisis is not getting better but Europe's banks are rallying round.

For much of last year the driver of currency trends was a combination of low rates and renewed risk appetite which saw the dollar weaken as the 'carry trade' came back and money flowed to higher yielding assets. The last three months have seen a new trend dominate as European currencies (including sterling) have suffered from the fall-out of Greece's crisis.

I expect the Greek crisis to abate but not to go away. On that basis, a correction in European currencies' weakness is likely but a turn is not. Near-term though, if fears about Europe do lessen the world we will return to will be the one we saw for much of last year – with a slightly weaker dollar, stronger high-yielding currencies, slowly rallying equity markets and probably higher government bond yields.

Today sees limited data, so sentiment will drive markets. I expect the Bank of Canada to remain dovish in obvious contrast with the RBA overnight.

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If there is a silver lining to the annihilation of the pound, it comes in the form of the continued return to health of the UK’s manufacturing industry. The purchasing managers’ index of manufacturing business sentiment came in at a slightly stronger-than-expected 56.6 in February, providing further encouraging signs that this sector at any rate continues to recover. As the Times puts it, ‘Industry grows at strongest rate in 14 years’ (click here). This points to further solid gains in industrial production ahead. The collapse of confidence in sterling is shocking against this backdrop. On a morning with limited news (the fact that there were few mortgage approvals in the midst of snowstorms means nothing to me), the sense that ‘the UK is the next sovereign debt domino to fall’ has increased. Opinion polls showing that the chances of a hung parliament continue to grow (click here) and negative weekend press (click here) don’t help. I’ve written before that I don’t agree with the view that the UK is going to collapse under the weight of its debt, nor do I think the economy is going to be mired in recession longer than its neighbours. The data continues to suggest that recovery is underway and that the UK will outgrow the European Union in 2010 and 2011. This will fuel a GBP recovery in due course – but for now, sentiment is at rock bottom and markets are incredibly volatile. The markets need either clear and credible plans to reduce the budget deficit or signs that the deficit is not growing as fast as feared. The next public finance data are not due for over two weeks. Between now and then (and potentially beyond) fear will rule.

Outside the UK, the main focus this week will be on the US payroll report and on efforts to find help for Greece in its funding crisis. The US data is going to be a bit of a dampener on confidence because weekly jobless claims have been trending higher in recent weeks. That may well say more about the weather than the underlying strength of the economy but, since everyone is still terrified of a drift back into recession, the data risk playing to those fears. The consensus looks for a 50,000 fall in employment in February. Before that we get January personal income and spending data today (look for small increases) and the February manufacturing business confidence index from the ISM. That is forecast to be marginally softer at a still-robust 58.0. This is consistent with on-going economic recovery and could provide some more support for the equity market where a fresh rash of M&A deals is breaking out (The Pru buying AIG’s Asian business and Coke buying its US bottlers, amongst others). It’s a case of two steps forward and one step back for the S&P index but I remain convinced that monetary reflation is the principal tool in policy-makers’ locker and that this will underpin equity indices.

I think some near-term help for Greece will be forthcoming. There is too much at stake for the European banking system so for Greece to get a bond away should be possible. Deutsche Bank CEO Josef Ackermann met Greek Prime Minister George Papandreou at the end of last week and I am sure there will be more conversations between both government and banking officials. This will not prevent either further credit downgrades in Greece or concerns about how to tighten fiscal policy sufficiently across Europe. In the longer term, the legacy of this fiscal crisis in Greece is that the ECB will be hamstrung – unable to tighten policy however hawkish some members feel. But in the near term, balance of risk has shifted and some positive news flow is likely. The euro is softer today and is on a longer-term downtrend, but I think it is due a bounce.

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