The start of the new month will test the resolve of investors to push world stocks to new 10-month highs with Japan's election and a G20 meeting greeting investors returning to markets after northern summer doldrums.
After Israel became the first key economy to raise interest rates this week, the London G20 gathering and central bank meetings in the euro zone, Australia and Brazil will give clues on the timing of "exit" strategies where policymakers unwind the huge liquidity-injection programmes they have put in place.
World stocks, measured by MSCI are on track for a seventh consecutive weekly gain this week, rising five of the last 6 months and up more than 21 percent since January.
Less than a year after Lehman Brothers collapsed, other risk assets have also staged a huge recovery. Oil prices are back at October levels, nearly doubling from January. Corporate credit spreads, measured by Markit's iTraxx Crossover index, have halved since March.
"We have a unique combination of nervous central bankers who will provide liquidity for some months yet and on the other side there is improving growth picture which is making the prospect of 2010 earnings and dividends attractive," said Guy Monson, chief investment officer at Sarasin & Partners in London.
"That is very bullish for real assets — equities, listed real estates and corporate credit. The market rally will continue with potential further appreciaton of equities through to Easter 2010. We have a six month window or so while we have the goldilocks situation."
A Group of Seven source has told Reuters that G20 policymakers will likely pledge to maintain accomodative policies for as long as is needed, like they said in the communique after the April meeting.
But some central banks will come under pressure to shift gears to contain inflationary pressures. Australia's central bank could adopt an explicit tightening bias next Thursday and possibly strong economic growth for the second quarter could pave the way for a hike as early as October.
The Reserve Bank of Australia is expected to keep its key cash rate at a record low of 3.0 percent next week.
DOG DIDN'T BITE?
The G20 has come to the forefront of rebuilding the global financial system after the worst financial crisis since the 1930s brought financial markets to a near collapse.
Since the G20 leaders agreed a $1.1 trillion deal in April to combat the crisis, the global economy has shown signs of a rebound. Japan, France and Germany have already come out of a recession, while major corporate earnings have been upbeat.
Ironically, the recovering economy and financial markets risk sapping the appetite and urgency to reform the system and putting the world back to where it was before the crisis.
"The crisis is of historic proportions by many metrics. Yet in some ways it was not strong enough to force a restructuring of the world economy onto a more balanced track," Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said in a note to clients.
"There will be regulatory adjustments, maybe some coordination and even cooperation, but the failure to take advantage of the crisis to put economies on a more balanced footing will have far reaching consequences that will likely reinforce powerful trends."
POLITICAL CHANGE
The other element which could complicate the work of the G20 is a possible change of governments in Japan and Germany.
Japan's general election is on Sunday and frustrated voters look set to kick out the ruling Liberal Democratic Party, which has been in power for much of the past five decades, and sweep the opposition to victory.
Financial markets would welcome a clear Democratic Party win which would remove a current parliamentary deadlock, but its spending plans and vow to keep the sales tax at 5 percent for the next four years have raised concerns that Japan's already huge public debt will grow further.
Germany will have parliament elections in the federal states of Thuringia, Saxony and Saarland next week before a general election in September.
Elsewhere, moves in Chinese stocks, a cause of recent volatility in global markets, would also be closely scrutinised.
Shanghai stocks fell 3.4 percent this week, posting a fourth weekly decline, as concerns lingered that China's economic recovery might be easing and the government might want to slow down lending growth.
