LONDON: World financial markets look set for further volatility amid ongoing uncertainty about the potential impact of inflationary pressures on interest rates, economic growth and corporate earnings.
"No-one should expect to see any change to the recent volatile conditions in the markets, particularly as the results season gets into full swing," said Stephen Pope, head of equity research at Cantor Fitzgerald Europe.
Concerns about inflation and growing risk-aversion., among investors have led to a miserable month so far for equity markets. The S&P 500 index has fallen 3.5 per cent since the end of September and the Dow Jones Industrial Average 2.6 per cent. In Europe, the Eurofirst 300 index has fallen 3.8 per cent from the three-and-a-half -year high reached at the start of October.
Bonds have also come under pressure, with the yield on 10-year Treasuries briefly rising above 4.5 per cent recently to the highest level for six months. Meanwhile, the Chicago Board of Trade's Vix index, an important barometer of investor uncertainty, hit a five-month high.
Recent comments from Federal Reserve officials and the minutes of the Fed's policy meeting on September 20 have left the markets in little doubt that the central bank is unlikely to be diverted from its interest rate-raising path. The question for many investors is how much further the Fed will need to tighten following the 11 quarter-point rate increases since June last year, which has taken the Fed funds target rate to 3.75 per cent.
Merrill Lynch has raised its forecast for the Fed funds rate peak from 4.0 per cent to 4.5 per cent but said it believed the Fed's inflation preoccupation was "overdone". Goldman Sachs, meanwhile, expects the funds rate to peak at 5.0 per cent by mid-2006.
The latest US consumer price data painted a rather mixed picture. The headline CPI rose by a bigger than forecast 1.2 per cent in September -- the biggest monthly gain for 25 years -- for an annual increase of 4.7 per cent, a level last reached in June 1991.
But the strength was largely caused by high oil and gas prices. The core CPI, which excludes food and energy, increased by a smaller than expected 0.1 per cent.
Mike Lenhoff, chief strategist at Brewin Dolphin Securities, believes Wall Street has been oversold recently.