Forex Investment and Currency Trading

The tension between still strong growth and higher inflation, and the consequence of higher rates will continue to define how risky assets perform going forward, in particular the relative performance of bonds versus equities. As long as the markets believe that rising bond yields are largely a by-product of good growth, not rising inflation, then equity markets should be
able to cope.

In this regard, it is important that central banks remain vigilant. Reassuringly, there is little sign that they are becoming complacent about the inflation risks. While the Fed is widely expected to leave the funds rate target unchanged at 2% on Wednesday, it is likely to signal that it remains focused on inflation (perhaps with the statement indicating less downside risk to growth and a modest increase in inflation worries).

This is not out of synch with the view that they will remain on hold through end-2009. Market forecast of below-trend growth for the next several quarters, if realized, should open up spare capacity that will enable core inflation to moderate further. Furthermore, market continues to believe that most FOMC members want to see three things before tightening: 1)
labour market improvement; 2) some clear signs of stability in the housing market; and 3) much more progress toward normalcy in the financial markets.

Importantly for risky assets, judging by the stability of inflation expectations over the longer term (as proxied by the 5yr 5yr forward expectations), the markets are fairly confident that the Fed is up to the job.