Uncertain week ahead for Wall Street

Setting aside the rights or wrongs of the issue, President Barack Obama's plan to strip banks of some of their clout is probably the last thing that world investors needed.

It adds another huge dollop of uncertainty to markets already struggling with rising sovereign debt risk, a disappointing Wall Street earnings season and macroeconomic headwinds ranging from rising inflation to stubborn unemployment.

Little wonder that world stocks as measured by MSCI are in negative territory for the year and heading for their second consecutive weekly loss.

But so far, it is more of a case of investors pausing than significantly retreating. The coming week - which is packed to the gills with economic data and more earnings - should give more of a clue as to whether this can hold.

"Markets have been set back by three important issues recently: 1) the Greek fiscal issues; 2) increasing worries about the prospect of China overheating; and 3) the U.S. banking sector proposals," Barclays Capital said in a note.

"Taken together the three issues add considerably to uncertainty about prospects for the global recovery."

Obama's proposal would prevent banks or financial institutions that own banks from investing in, owning or sponsoring a hedge fund or private equity fund, would set a new limit on banks' size in relation to the overall financial sector and could bar them from trading for their own profit.

At the very least, the plan will raise a huge question mark over the financial sector, and one that could hang there for a long time as legislation in Washington and other countries following suit is fought out.

"I don't know how you value a bank now," said one strategist, who like many in the banking industry on Friday was not keen to be named on this issue.

DOMINOS

Underlying Obama's plan is a desire to curb risk taking at big institutions in order to spare government from future industry bailouts as seen over the past couple of years.

Those bailouts have at least in part led to the second major concern facing investors -- sovereign risk stemming from uncontrolled spending.

The spread between Greek government bonds and benchmark German Bunds blew out to a euro zone record as investors fretted about the sustainability of Greece's huge debt and deficit and there were the first signs of contagion, with Portuguese and Spanish debt spreads also widening.

Portugal, though not in as poor a shape as Greece, is widely considered the next country to come under stress if worries about Greece spill over into other euro zone peripheral economies.

This is how great crises can begin, as emerging market investors in the 1990s found out on a couple of occasions.

So investors next week will be keenly focused on the euro zone peripherals and in particularly on what impact there may be on the foreign exchange markets.

Partly because of worries about Greece and others, the euro fell to a near six-month low against the dollar this week.

"The story for euro/dollar has largely been one of a positive correlation with equities," said Peter Lucas, investment strategist at RBC Wealth Management. "The Greek thing certainly has changed things in the short term."

More euro weakness could well be a feature of the coming week. "Put" options, the right to sell the euro, are currently more expensive than "calls," the right to buy, suggesting the market is euro bearish and expects more volatility, particularly over the next few weeks.

SNAKES AND LADDERS

The global macroeconomic picture, meanwhile, will come into focus in the coming week through a series of data releases and central bank meetings.

Fourth-quarter gross domestic product data from Britain and the United States will give some idea of how the recovery is progressing in the developed economies, while new International Monetary Fund forecasts should give a broad overview and a steady stream of comments is expected from the annual World Economic Forum meeting in Davos.

Inflationary pressures, and the attendant possibility if sooner interest rate hikes than expected, will be in focus.

The Federal Reserve policy-making committee meets next week and its views will be crucial, of course, but there are also a raft of central bank meetings from South Africa to Israel and Brazil.

"Inflation in emerging markets is going to come in much stronger than people realize," said Charlie Morris, head of absolute returns at HSBC Global Asset Management.

Another headwind for investors to face.

- Reuters