Inflation or Economic Growth?

Global capital markets remain caught in a tug of war between inflation and economic growth. For most of 2008, the economic growth story prevailed as the Federal Reserve Bank cut interest rates aggressively to cushion the blow from the housing crisis. However, the pendulum soon swung to inflation and the Fed began to worry that perhaps it had lowered rates too far and may in fact need to hike them in response to surging food and fuel prices. In fact, the European Central Bank recently hiked its benchmark interest rates. Now, a slew of negative economic data threatens to shift the rhetoric back to the other corner. Securities and currencies have fluctuated wildly over this period, and investors remain unsure about which side the world’s Central Banks will err on. Currency traders need to look no further than credit markets for a snapshot of the current consensus, which often presages changes in currency valuations. A quick and dirty analysis would place American and Euro-zone short-term bonds side by side and compare the yields (or prices), as a proxy for the EUR/USD exchange rate. The Wall Street Journal reports:
Two-year yields in all three markets have been on a wild ride in June, driven up by tough inflation rhetoric from central banks, then down again by renewed worries about the credit crisis and the state of financial markets