Global markets have been treading water during the past couple of weeks.  They are hindered by the Ukraine crisis, the US reporting season, and poor Chinese PMI numbers.  On the plus side speculation that the European Central Bank might loosen monetary conditions has supported the markets.
First to Europe, where the President of the ECB Mario Draghi has been talking the talk, but not walking the walk when it comes to loosening money supply. But with inflation maybe dropping to just 0.5 per cent; and the Euro strengthening, there might just be enough pressure for him to take action and provide monetary stimulus and/or quantitative easing.
The expectation of further monetary loosening has prompted a movement of funds into Southern European bonds causing yields to fall substantially compared 2010. We believe current yields are hard to justify in terms of the outlook for these countries.  There is a risk yields at these levels will undermine current reform programs and fiscal discipline.
Against this backdrop, the Euro has defied market expectations to hold its ground against the US Dollar. Support for the Euro is being provided by the flow of funds into European bonds; the ECB’s shrinking balance sheet; and the improving economic picture for Europe.
The Ukraine crisis is a story that has not gone away. The G7 has announced it will intensify sanctions against Russia.  Markets will be keeping a close eye on the situation focusing on the type and form of sanctions imposed, which are currently still mild. 
The existing sanctions are already beginning to take their toll on the Russian economy.  The Russian central bank recently surprised the market with a 50bp rate increase; whilst S&P downgraded the country’s debt to one notch above junk.
Besides European inflation the main economic news this week will be from the US.  The US Federal Reserve, which meets this week, is expected to continue tapering; with another $10 billion coming off the program. The US employment report will be released at the end of the week.  We expect around 230,000 jobs to be created; with a fall in the unemployment rate to 6.6 per cent.
A final word on Australia, where the Dollar continued its retreat from $0.95. This was driven by an inflation report that was not as bad as expected, and poor economic numbers out of China.  The lower than expected inflation reduces the need for the RBA to raise rates imminently.   We also did not think that the latest Chinese numbers were as bad as the market thinks. The number seems to indicate that the slowdown in economic activity has begun to moderate.