US bonds hold key to markets' direction

TREPIDATION in the markets following Friday's bloodbath was tempered over the weekend as strategists reconsidered whether fears of rising interest rates in the US were justified, writes John Willcock.

All eyes will be on the American bond market today, with optimists banking on Wall Street's recovery on Friday. Developments are expected to overshadow domestic UK indicators, including factory gate inflation figures today and manufacturing output data on Friday.

However, some expect today's inflation figures could be better than expected and help to perk up the domestic markets.

Several global strategists in the City expect Friday's Wall Street rally to spill into Europe today. The general sentiment is that it will probably be a plus day.

This leaves the question whether equities face more significant problems. Strategists feel the correction has further to go, but there is no agreement on how much further.

Sudden fear of a rise in US interest rates last week triggered the present unease. City analysts think that in the summer people were too optimistic about the US economy, whereas today they are probably too pessimistic.

There is a feeling that the rate fears are wrong but that it will take time for the markets to accept this. Meanwhile, yields on the 30-year US bond, for instance, could rise to 6.5-6.6 per cent after hitting 6.25 per cent on Friday following strong US employment figures.

There is no justification for raising interest rates anywhere outside the US, but policy-makers may be unable to resist making existing exchange rate parities a priority.