Short view By Philip Coggan - Financial Times

Short view
By Philip Coggan
Published: February 7 2006 02:00 | Last updated: February 7 2006 02:00. Copyright by the Financial Times

The bulls and bears seem to be gearing up for a climactic battle that may determine the direction of financial markets for the rest of 2006.

The bulls can cite the increasing level of takeover activity (Mittal for Arcelor, BNP Paribas for BNL), strength in profits and expectations of a peak in US rates later this year.

Those of the ursine persuasion can point to geopolitical threats, such as the Iran nuclear standoff or tension between the US and Venezuela, the inversion of the US yield curve, or the warning signs being sent by the sharp rise in the price of gold.

Each camp could take some comfort from Friday's non-farm payroll numbers. The headline rise in employment was lower than expected but there were upward revisions to previous data and the unemployment rate dropped from 4.9 to 4.7 per cent. The bulls could see this as a sign of the continuing strength of the US economy; the bears as an indicator of the need for further interest rate increases.

Analysts now seem to be upgrading their forecasts for first-quarter US gross domestic product growth; Barclays Capital is going for an annualised rate of 4.5 per cent and there is some talk of a 5-6 per cent figure. This will reflect a rebound from the weak fourth-quarter numbers but it will make it difficult for the Federal Reserve to decide where the peak in rates should be.

The high price of oil, and other commodities, is simply adding to the confusion. On the one hand, rising commodity prices can be seen as an indicator of buoyant global demand and to economists such as David Ranson of H C Wainwright the high price of gold is a signal of inflationary pressures. But the persistence of the oil price at around $65 a barrel is a potential threat to consumer demand. And an inverted yield curve (the two year Treasury bond yields more than the 10 year) is normally a sign of economic slowdown.

All this could come to a head in the next few months. If early signs are that US economic strength will persist into the second quarter, then long bond yields must move higher. But if the Iranian dispute escalates so that oil hits $80 or $90 a barrel, bond yields may fall and growth expectations (and equity markets) will take a hit.