Five world markets themes in the coming week

LONDON (Reuters) - Following are five big themes likely to dominate thinking of investors and traders in the coming week and the Reuters stories related to them.

1/ HEADY STOCKS

A rotation out of major emerging markets into developed country equities has helped lift the MSCI All-Country World Index so far this year and is leading some in the market to question whether the rally could be set for a pullback. The S&P 500 is double its value two years ago but volumes are relatively low, Brent crude is at 2-1/2-year highs in part on tension in the Middle East and inflation is accelerating across the globe, leading markets to raise their bets on higher interest rates. At the same time government bond yields are off their recent highs, suggesting some investor nervousness about valuations. Further signs of central bank hawkishness or weak data, especially in the United States, may be enough to force a pause for breath at still elevated levels, even if not a major correction.

2/ CHINA CHIMES IN

While global imbalances - a major G20 bugbear - have been less in focus of late, there is growing speculation that some Asian countries, led by China, may allow their currencies to appreciate against the dollar at a measured pace to insulate their economies against rising imported inflation. That could bring the dollar under renewed downward pressure against Asian currencies. But elevated U.S. yields will give the greenback a boost against the yen. Two-year U.S. Treasury yields have risen about 26 basis points this month and the correlation with dollar/yen, which had broken down last year, is re-establishing itself.

3/ BANKS IN SPOTLIGHT

European banks, benefiting from cheap valuations and from the rotation from emerging markets to developed markets, have risen nearly 16 percent so far this year, outpacing their U.S. peers measured by the KBW Banks index .BKX. Europe's banking sector remains attractive as it has a 12-month forward P/E of 9.3 times versus the STOXX Europe 600's 11.1, though banks' consensus earnings are expected to be double on average those of firms in the broader index. The rally in European banks also helps fuel the gains in the broader European markets, with Germany's DAX and Italy's FTSE MIB also trading in overbought territory. Results from Royal Bank of Scotland, Lloyds, Commerzbank and Credit Agricole will either provide further fuel for the rally or a timely reality check, while the outcome of Ireland's election on Friday may also weigh on the sector as the two main Irish opposition parties, expected to form a coalition government, want to renegotiate the country's international bailout, possibly threatening plans to recapitalize Irish lenders.

4/ BALANCING INFLATION AND GROWTH RISKS

Benchmark global government bond yields, though off recent highs, look set to maintain their upward trend on concern about inflation pressures. But how well central banks manage to balance these risks while fostering recovery will determine the pace of the bear steepening of bond curves. (February flash China and euro zone PMIs are released on Monday). The European Central Bank is maintaining its hawkish tone on mounting inflation pressures in the euro zone while investors are pricing in greater chances of the Federal Reserve tightening rates more quickly than the Bank of Japan, which is still facing deflation. The minutes of the latest Bank of England meeting will be keenly watched on Wednesday to see if any more policymakers voted for a rate hike. A key focus will be whether markets remain fixated on inflation pressures alone when anticipating future rate rises and whether this will translate into gains for currencies.

5/ FIGHTING FIRES

A rise in five-year Portuguese bond yields to euro-era record highs above 7 percent shows how sentiment toward lower-rated euro zone debt remains fragile even with the European Central Bank apparently ready to intervene to buy paper. The longer yields stay above levels close to which Greece and Ireland were forced to seek bailouts, the greater the pressure on Portugal to ask for international aid. The economic costs of austerity are showing up in gross domestic product data and are also causing a feedback loop into yields as investors factor in the damage to revenues and higher welfare outgoings. Signs that the ECB might be confining itself to buying the worst hit peripheral bonds were partly behind the persistent widening in Greek bond yield spreads over German benchmarks though the moves could be exaggerated by thin liquidity. Given its role as chief fire-fighter before a definitive EU-wide deal is reached in March, the size of ECB bond purchases due early in the week may see a wider sell-off if they are perceived to be no more than a token gesture to keep bond market vigilantes at bay.

(Compiled by Nigel Stephenson and Dominic Lau; Editing by Ruth Pitchford)