Periscope

The first to be flattened will be U.S., British and Australian bond and property markets. Emerging markets are next, since foreign investors tend to leave when returns improve at home. Bond markets in Brazil and Turkey look particularly vulnerable.

The good news: the upheaval is likely to be gentler than it was after Fed hikes in 1994. Rising rates have already been priced in to many assets, and mortgage rates are so low that minor upward moves may not dampen property markets by much. Falling barriers to rising capital flows have produced what some analysts call "synchronized" markets, in which recession and reflation is a global (not just national) cycle. So if expensive money does cause more misery than expected, at least we'll all have company.
--Jonathan Adams

BRITAIN
Fighting on Two Fronts

In a public scolding unprecedented for a British prime minister, 52 former senior British diplomats last week called for a "fundamental reassessment" of Tony Blair's handling of Iraq and the Middle East peace process. Now the prime minister may be in jeopardy of losing the support of his military, too. The aftermath of the U.S.-led war has been "an unholy mess," says one retired senior British officer. "[And] it would be very hard to find a single retired officer of senior rank who supported the invasion of Iraq in the first place."

Demands from Washington are likely to worsen Blair's relationship with serving generals as well. The White House wants more British troops in Iraq--2,000 is the rumored figure--to replace the departing Spanish. If the Poles cut their forces, too, as they're hinting they may, Washington will likely urge British troops to take over command of the holy Shiite city of Najaf, home to rabble-rousing imam Moqtada al-Sadr. Blair, sources say, is facing adamant opposition from Britain's military chiefs, who have publicly declared the U.S. approach to pacifying Iraq a cause of "friction." In private, the criticism has been far stronger: at a closed-door session in London in November, top British generals warned their U.S. counterparts that the U.S. and British approaches to counterinsurgency were so different that their forces were "not interoperable." British commanders are now deeply reluctant to see their soldiers' lives risked in the hornets' nest that they believe the U.S. approach has stirred up in Najaf.

Blair's political standing is still relatively secure, mostly because his likely successor as Labour leader, Chancellor of the Exchequer Gordon Brown, shows no inclination to challenge him before next year. But even Blair's most loyal supporters accept that the sky--which was once the limit--could fall.
--Stryker McGuire and John Barry