By Natsuko Waki
LONDON, Sept 18 (Reuters) - With world stocks already having recouped two-thirds of their 2008 losses, any wavering of policymakers' commitment to a super-loose fiscal and monetary policy framework could rock investor faith in the rally.
Next week's Group of 20 summit in Pittsburgh, the Federal Reserve meeting and the minutes of the Bank of England's latest policy meeting are the risk events to watch out for, especially as the G20 pledge earlier this month to keep emergency economic support in place triggered the latest leg of the rally. The benchmark MSCI world equity index hit a fresh 11-month high this week, bringing its gains since January to more than 27 percent, belying fears that risky assets are in imminent danger of a major correction.
However, too-loose monetary policy when the economy is recovering -- some G7 countries have already returned to growth -- could stir inflation.
"Investors are happy to embrace risk as cash and bond yields are very low. Some of them have entered on the assumption that interest rates are going to stay very low. If that view is challenged, some of that money will exit the market," said Peter Lucas, investment strategist at RBC Wealth Management.
Lucas noted that positive economic surprises could actually spark a sell-off in stocks and other risky assets if they cause speculation of tighter monetary policy and lead to a rise in bond yields.
"How close are we for positive growth surprises to lead to correction? U.S. two-year yields are bottoming out and it could be quite imminent," he added.
Two-year U.S. Treasury yields are hovering around 0.94 percent, having occasionally dipped below 0.9 percent in recent weeks.
The Fed has pledged to buy up to $1.45 trillion of mortgage-backed securities and debt issued by government sponsored Fannie Mae and Freddie Mac by end-2009.
Richmond Fed president Jeffrey Lacker, who is a voting member of the policy committee, said earlier this week it probably made sense to taper the asset purchase programme down rather than end it in December.
CORPORATE ACTIVITY
Investors have stepped up the pace at which they withdraw capital from safe money market funds. In the week to Sept 17, they pulled $47.2 billion out of this asset class -- the second biggest weekly outflow -- according to fund tracker EPFR Global.
Since January, outflows from money market funds totalled $331.9 billion, or a little over 10 percent of their assets.
Global equity funds attracted $1.74 billion for the week.
In a sign that investors are buying equities for reasons more than just valuations, optimism on corporate profits and activity is rising and further possible deal announcements could further reinforce this.
More than 60 percent of fund managers surveyed by Merrill Lynch believe global corporate earnings can rise by 10 percent in coming months.
According to Thomson Reuters data, global M&A rose 29 percent between June to August from the previous 3 months.
"M&A overall is clearly going to be a theme as it can be a helpful trigger point. It gives investors an excuse to take part in equities," said Gary Baker, international investment strategist at Bank of America Securities-Merrill Lynch.
Financial services firm Deloitte says its pipeline of deal activity has tripled since June.
"We expect to see a significant increase (in initial public offerings) in 2010, and are already seeing companies jostling on the start line," said John Hammond, corporate finance partner at Deloitte.
"A small number of these companies may be sufficiently ahead of the game to IPO before the end of the year, but we expect to see the majority in 2010. This, of course, is assuming there are no major shocks to the stock markets in the meantime."
(Editing by Toby Chopra)