September 22, 2009
With world stocks already having recouped two-thirds of their 2008 losses, any wavering of policymakers' commitment to a super-loose fiscal and monetary policy framework could rock investor faith in the rally.
This week's Group of 20 summit in Pittsburgh, the Federal Reserve meeting and the minutes of the Bank of England's latest policy meeting are the risk events to watch out for, especially as the G20 pledge earlier this month to keep emergency economic support in place triggered the latest leg of the rally.
The benchmark MSCI world equity index hit a fresh 11-month high this week, bringing its gains since January to more than 27 percent, belying fears that risky assets are in imminent danger of a major correction.
However, too-loose monetary policy when the economy is recovering - some G7 countries have already returned to growth - could stir inflation.
"Investors are happy to embrace risk as cash and bond yields are very low. Some of them have entered on the assumption that interest rates are going to stay very low," said Peter Lucas, investment strategist at RBC Wealth Management.
"If that view is challenged, some of that money will exit the market," Lucas said.
He noted that positive economic surprises could actually spark a sell-off in stocks and other risky assets if they cause speculation of tighter monetary policy and lead to a rise in bond yields.
"How close are we for positive growth surprises to lead to correction? US two-year yields are bottoming out and it could be quite imminent," he added.
Two-year US Treasury yields are hovering around 0.94 percent, having occasionally dipped below 0.9 percent in recent weeks.
The Fed has pledged to buy up to $1.45 trillion of mortgage-backed securities and debt issued by government sponsored Fannie Mae and Freddie Mac by end-2009.
Richmond Fed president Jeffrey Lacker, who is a voting member of the policy committee, said earlier last week it probably made sense to taper the asset purchase program down rather than end it in December.