Bracing for QE2 final countdown

Investors are preparing themselves for further market tension.

Investors are preparing themselves for further market tension as Europe8217;s debt crisis lingers on while data surprises on the downside just when the countdown to the end of the U.S. bond buying programme begins in earnest.

World stocks,measured by MSCI,are set for the fourth consecutive weekly losses,with their year to date gains shrinking to just 3.6 percent from nearly 9 percent earlier this year.

A retreat in risk tolerance stems from softening in data 8212; most recently fresh signs of a slowdown in the U.S. labour market and weaker-than-expected U.S. first-quarter growth.

Barclays Capital says its data surprise index for the euro zone,the United States,Britain and Japan is firmly in negative territory with downward surprises as sharp as during the worst of the global financial crisis in autumn 2008 on some measures.

Data in the coming week,including U.S. and German jobs reports and euro zone inflation,will be key in determining whether investors accelerate risk unwinding ahead of the end of the 600 billion Treasury purchases QE2 in June.

But that is not to say investors are seriously worried about yet another round of the Federal Reserve8217;s easing programme and considering moving back to risk-averse positions involving buying government bonds and money market instruments.

8220;The data in the U.S. are patchy8230; but we think that the Fed will stick to what it has said already. If the data continues to disappoint you may find the bond market begins to think the Fed will change its mind,8221; said Kevin Gardiner,head of investment strategy at Barclays Wealth.

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He added that potential wobbles in the bond market from data disappointment may offer opportunities to sell bonds.

Goldman Sachs said its recent growth forecast downgrades in economies of the United States,China and euro zone will erode near-term returns among different asset classes,although its global growth estimate is still robust at 4.3 percent.

8220;As earnings and multiples erode,equity markets will have less upside potential than before,8221; Goldman said in a note to clients.

8220;It is,however,important to reiterate that we remain meaningfully constructive across equity markets,with year-end expected returns now running in low double-digits.8221;

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It expects the Samp;P 500 index to end the year at 1,450 8212; nearly 10 percent higher than now 8212; Europe8217;s STOXX 600 at 320,TOPIX at 900 and MSCI Asia-exJapan index at 530.

DEBT CRISIS AND ECB

The euro zone sovereign debt crisis will likely remain an issue that would weigh on investor minds,with a particular focus on whether Greece would need to restructure its debt as it faces a 13.4 billion funding crunch next month.

Investors are jittery after Jean-Claude Juncker,head of euro zone finance ministers,said on Thursday the International Monetary Fund could withhold the next slice of aid to Greece due next month in a comment which some analysts said was designed to pressure Greek political leaders to act.

Portugal may also come into focus in the coming week as the country prepares for a general election on June 5.

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The International Monetary Fund technical mission is expected in Lisbon in May 30-31 to accompany the implementation of the 78-billion-euro bailout plan agreed last month.

The euro zone debt crisis is likely to lead to material asset allocation changes if it changed euro zone interest rate expectations. Investors currently expect the European Central Bank to raise interest rates by a quarter point by end-2011 after raising them last month to 1.25 percent.

8220;The course of events will remain very changeable and some politicians8217; desire to 8216;burden share8217; remains a source of event risk. The short end looks more attractive for the moment as upcoming weaker activity data and EMU stress may impact ECB hikes expectations,8221; BNP Paribas said in a note to clients.