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Speculative trends have been slow to recover from the year-end lethargy that seemed to set in two months ago. Nonetheless, the US dollar has seen its ability to capitalize on the stalled drive in risk appetite diminished by that same stability and the development of a few other fundamental concerns.

The Economy and the Credit Market

Speculative trends have been slow to recover from the year-end lethargy that seemed to set in two months ago. Nonetheless, the US dollar has seen its ability to capitalize on the stalled drive in risk appetite diminished by that same stability and the development of a few other fundamental concerns. Today, the minutes from the Federal Open Market Committee’s (FOMC) last policy meeting squashed burgeoning speculation that interest rate hikes could be in store for the near future. Throughout 2009, the market was pacified by central bank Chairman Ben Bernanke’s suggestion that the next rate decision would not come until at least the middle of 2010. This was a loose target; but the tangible efforts to withdrawal stimulus from their emergency aid programs offered traders a clear stepping stone towards the inevitable. However, in recent commentary, the time frame for a decisive hawkish move grew increasingly vague. Today’s report revealed the debate for a hike was not progressing well. The minutes reported a deliberation over whether asset purchasing programs should increased and extended should the economic recovery soften. What’s more, some officials argued that the slack in the economy would likely contain inflation pressures. In reaction to the event, interest rate expectations tumbled for a third day, reversing the hawkish trend that had built up throughout December. Now the dollar’s best hope is for risk appetite to collapse.

A Closer Look at Financial and Consumer Conditions
Financial conditions are improving rapidly: at least that is what recent data and indicators are suggesting. Yields on mortgage securities reported their lowest spreads relative to government paper of the same maturity in 17 years; while the riskiest grade of corporate bonds rose above ‘distressed’ levels for the first time since June of 2008 after a report that the asset class marked its second biggest one-day offering on record. The markets are the ideal barometer for risk; but that does not mean they are neither rational nor stable. On the same breathe, data revealed corporate bankruptcies surged 50 percent last year; and there are many other cracks in the system. All that is needed is for one of these threats to materialize and shake sentiment.	Data released this past week has supported a gradual recovery in the US economy. However, if we were going by the pace of the capital markets, it would seem that investors believe the nation has turned a sharp corner and is now on an aggressive trajectory. Today, policy officials allowed for a slight bullish adjustment to their growth forecasts – commenting that they had “modestly increased” their projections for activity in 2010 and 2011. There has been a strong rebound in business activity and a few other corners of the market; but the true gait of recovery rests with core components of the economy like employment, credit, consumer and foreign demand. For a contrast in reality, watch Friday’s NFPs for the reaction to a modest improvement.

The Financial and Capital Markets

Risk appetite has not lost significant ground in nearly two months; but neither has it advanced very much in that period either. There are few asset classes that have climbed in recent days (mainly the physical commodities); but on the whole, investors are awaiting guidance before they plow additional funds into the market. Through most of 2009, market participants were comfortable with diversifying money that was previously held in safe-haven assets because they were drawn by the quick capital gains that could be made. However, since stalling, the opportunity to turn a quick profit after the Dow has rallied more than 60 percent and gold is pushing record highs seems unlikely. With any further appreciation likely to come at a more controlled pace, investors will be more frugal in where they place their capital. In a fastidious environment, the severe lack of yield, coupon payments and dividends offers little incentive to heavily speculate. At this point, the markets are more exposed to a correction than a steady advance.

A Closer Look at Market Conditions
Capital markets are offering a divergence in pace; but the bearing is consistent across the spectrum. Equities, commodities and fixed income are all reflecting a market that is more tolerant of risk and that is hungry for yield. However, recent activity perhaps show a greater level of ‘rationality.’ The benchmark Dow Jones Industrial Average is still rising; but it is a gradual advance that has allowed now more than 300 points of volatility for two months. Speculators looking for a quick profit have turned to the commodity market. With no regular source of income, traders have driven securities like crude on a sharp swing. Oil is now in its strongest advance in 13 years.	Traditional risk indicators are showing few signs of excess. However, should signs like a two-year low in junk bond spreads and a 170-year low in mortgage spreads be construed as a reasonable development in the course of the economic and financial recovery? This is a debatable point. Growth trends have certainly improved and the markets have stabilized; but that does not mean that conditions will continue to improve. In fact, with expansion and expected returns expected to level off, and considering the world’s governments will eventually have to withdrawal their unprecedented stimulus packages; speculators may soon be encouraged to book profit