MARKET REACTION:THE FRAGILE nature of investor risk appetite was underlined yesterday as uncertainty over US monetary policy overshadowed easing concerns about Greece and sovereign debt risk.

US stocks gave back a large chunk of the previous day’s advance, commodity prices went into retreat and the dollar rallied as US Federal Reserve chairman Ben Bernanke addressed the ultimate withdrawal of liquidity in the markets.

In a prepared statement for the House financial services committee, the Fed chief said the gap between the discount rate and the Fed funds rate might see a modest rise “before too long” as part of the “normalisation” of lending”.

But he said such a move would not signal any change in the policy outlook as he also reiterated a pledge that exceptionally low rates would be warranted for an extended period.

Mr Bernanke’s remarks offset a growing sense of optimism that the EU would provide a bailout for Greece, and possibly other fiscally challenged euro-zone nations such as Portugal and Spain.

They also overshadowed robust Chinese trade data, while news of a bigger-than-forecast US trade deficit had only a muted impact.

Greek government bonds attracted a wave of buying interest, with the yield on 10-year paper tumbling 40 basis points to 5.99 per cent and its spread over German Bunds narrowing 45 basis points to 284 basis points.

The cost of insuring against a sovereign default by peripheral euro-zone nations also fell sharply. Greek five-year credit default swaps plunged 66 basis points to 355 basis points, according to data from Markit.

However, analysts were sceptical that a special EU summit today would result in concrete proposals for a bailout for Greece.

Erik Nielsen, chief European economist at Goldman Sachs, warned that political leaders were unlikely to agree to more than some guidelines for how a rescue plan might take place.

“A firm commitment is virtually impossible, partly for the reason that bilateral lending would have to be approved by the national parliaments, if it goes beyond small amounts inside their cash holdings for a very short term,” he said.

This uncertainty helped to halt the previous session’s strong rally for the euro. Mr Bernanke’s comments provided a further fillip to the dollar and weighed on short-dated Treasuries. – (Copyright The Financial Times Limited 2010)