Can we breathe a sigh of relief? More fierce trading yesterday left some European stock indices back in positive territory for the year – in spite of last week’s sell-offs – with US stocks following them.

For now, this is due to waves of risk appetite and aversion, rather than economic fundamentals. This is most evident from the correlation between the dollar’s level against the yen and the level of the S&P 500, which has been almost perfect over the past week. They have risen and fallen together, almost in unison. This has to do with fear: a rising yen could scupper the easy “carry trade” money being made from borrowing at the yen’s cheap interest rates, and this in turn could lead to money being pulled out of stocks. With the yen subsiding, traders are less nervous.

How has the view on the fundamentals shifted in the past two weeks? The Bank of England avoided any surprises yesterday, leaving rates unchanged. Meanwhile, hopes rose that the European Central Bank would soon stop its monetary tightening. As universally expected, it raised its main “refi” rate to 3.75 per cent, but made clear that it would not raise again at its next meeting. Jean-Claude Trichet’s comments were more Delphic than usual, but by saying that rates were “on the accommodative side” rather than just “accommodative” he appears to have signalled that the tightening campaign does not have much longer to go. Many now think the ECB will stop at 4 per cent.

On to the US Federal Reserve, which next meets on monetary policy this month. Here, sentiment has shifted fast. On Monday last week, the prices of Fed Funds futures implied a zero chance of a move from the current rate of 5.25 per cent in the next six months. They now imply that by August, a cut at least as far as 5 per cent is a certainty. This is because fears of declining growth have risen during the sell-off. The next test of US growth – and opportunity for stocks’ recovery to go into reverse – comes with today’s US non-farm payroll data for February. They cause convulsions in the market at the best of times. With nerves on edge, they may well do so again.

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