The first two weeks of July were dark indeed, as investors feared that high oil prices were both heralding recession and preventing central banks from taking action by cutting interest rates. That environment was pretty bleak for risky assets, with equities falling and credit spreads rising. The repeated falls in the share prices of Fannie Mae and Freddie Mac added to the sense of crisis.

Two things then changed the tone. The first was a fall in the oil price from its $147-a-barrel peak. The second was the rescue of Fannie Mae and Freddie Mac and some better-than-expected results from the banking sector. The market's economic and financial worries were eased at the same time; equities rallied sharply (particularly bank stocks) and credit spreads narrowed again. The ten-year Treasury bond yield rose in a week from 3.83% to 4.15%.

But on July 24th, the markets suffered a relapse. A set of negative economic data in Europe and America, together with fears about the health of Washington Mutual, sent the Dow Jones Industrial Average down 283 points and pushed the ten-year Treasury bond yield back down to 4.02%.

All this volatility has led to some contradictory-looking moves. Normally gold is seen as a hedge against inflation. You can thus count on the bullion price to rise as Treasury bond yields are increasing. But as the chart shows, this has not been happening since mid-July. Gold has been moving hand-in-glove with oil (as part of the commodity asset class) and in the opposite direction of the dollar (since it is seen as an alternative currency).

This market chaos is understandable; the trade-offs are complex. The fall in the oil price will eventually bring the headline inflation-rate down. That sounds like good news for both equities and government bonds.

But what if the decline in the oil price is the result of a global recession? That would hardly be positive for stock markets. And what if a falling headline inflation rate gives the green light for the central banks to cut interest rates? Coupled with the willingness of the authorities to rescue the banking system, that would suggest a long-term inflationary bias in the economy and thus be bad news for Treasury bonds. “Investors should not be distracted or trapped into dismantling portfolio inflation defences by either the current growth slowdown or by the vagaries of the spot oil price,” says Tim Bond, head of global asset allocation at Barclays Capital, in his latest note.

Despite Mr Bond, investors show every sign of being distracted by the details of the current slowdown. The latest euro-zone purchasing managers' survey, for example, appeared to point to a second-quarter fall in GDP. The highly erratic British retail sales numbers for June wiped out the strong gain recorded in May. American initial jobless claims jumped to 406,000 in the latest week, while existing home sales dropped to their lowest level in a decade. As Alan Ruskin of the Royal bank of Scotland remarked, this was a contest among the G7 nations to see who could post the worst numbers.

What makes the situation so obscure is the leads and lags in the economic data. The global economy is still absorbing the impact of the rise in oil above $100 a barrel, let alone its subsequent gains. And the Federal Reserve's long series of rate cuts are still working their way through the system. Then there is the American tax rebate, still sitting in many consumers' bank accounts.

That suggests both the inflationists and the deflationists are going to have plenty of ammunition over the next few months. In turn, that will make it hard for investors to make a decisive choice, and that means the volatility in financial markets will continue over the next few months.

Long term, the inflationists look to have a better case. The world has paper money and the central bank that runs its reserve currency (the dollar) has repeatedly erred on the side of loose monetary policy, for economic and financial reasons. Emerging markets, nowadays the drivers of global growth, have loose monetary policies in aggregate. Treasury bonds may occasionally benefit from flights to safety over the next few months, particularly as the banking sector continues to struggle. But it is hard to believe that yields of 4% or so will look good value in five years' time.