World market themes to watch

Following are five big themes likely to dominate thinking of investors and traders in the coming week.

1/ ONE STEP BEYOND

Yen strength has not being dented noticeably by indications the Bank of Japan will sooner or later join the US Federal Reserve in QE2. With QE already well established in Japan, the BOJ has the option of expanding its supply of funds or extending the duration of the cheap fixed-rate loans it makes available to banks.

Given the FX backdrop and the market's policy expectations, a meeting next week between Japan's prime minister and central bank governor has grown in market importance.

Announcements - or a lack of them - risk triggering sharp swings in the yen and Japanese assets. And if the yield differential between US and Japanese government bond yields remains as correlated with the dollar/yen rate as it has been recently, Japan's FX tolerance limits will continue to be tested.

2/ MONEY FOR (PRACTICALLY) NOTHING

The short end of top-rated government bond yield curves is pinned down at low levels by expectations that central banks will keep official interest rates low.

Given the minimal yield offered by shorter maturities, investors are looking to longer-dated assets to secure cash flows. This has led to a marked flattening in the US and German government bond yield curves and driven long-dated euro and US interest swaps to multi-month lows. While interest rate markets have been helped by concern over prospects of a double-dip recession in some major economies, some are starting to flag the possibility that there is a bubble in the making at the longer end of government bond yield curves.

Inflation-linked bond markets are still showing market inflation expectations are broadly anchored but the first signs that recession concerns are overdone would trigger an unwinding that will not spare the long end.

3/ MAKING YOUR MIND UP

World equities are down only 4 percent so far this year and well off their March 2009 troughs even though government bond yields have been falling across the curve, suggesting that concern about the risk of a double-dip recession in the United States and some other major developed economies has yet to exert as strong an influence over stock markets as it has over interest rate markets.

It will take more economic data to show which asset class is best positioned and if that means more investors holding off making big bets, it will be bad news for investment banks who are looking for better fixed income, currencies and commodities revenues in September to make up for low trading volumes in July and August.

4/ VOGUE

M&A is back in vogue with those companies who are flush with cash and looking to expand or diversify their earnings stream through firms with niche products in current environments where valuations are cheap (eg BHP Billiton for Potash, RSA for Aviva's non-life unit, Vedanta Resources taking a stake in Cairn Energy's Indian unit).

But given large-cap firms with strong brands and financial muscle are already better able to fund expansion, it will be how less cash-rich firms join in that will influence the extent to which such activity can buoy equity markets and determine how strongly M&A activity can be seen to be signaling improved corporate confidence.

5/ TROUBLED WATERS?

A string of relatively successful debt auctions from peripheral euro zone sovereign issuers has soothed concerns for now about their ability to fund themselves and put a lid on the trend toward wider yield spreads that had begun to re-emerge.

Debt auctions will slow to a trickle in the week ahead before picking up in September. Ireland, which was the focus of recent concerns about the cost of banking sector bailouts and which led the recent round of spread widening, will return to the spotlight given the large amounts of bank bond repayments due.

Spain also has the potential to trigger market jitters if its €500 million ($899 million) revival of public works projects turns out not to be a one-off - all the more so given Moody's will decide in the coming months whether to strip the sovereign of its precious triple A status.

- Reuters