Bond Outlook September 14th

While the short-term impact of Katrina still seems moderate in the context of the overall strength of the US economy, the longer-term effect is looking more menacing. The damage from Katrina means that insurers will raise cash by selling bonds from their portfolios to meet their indemnities, and the Treasury will do likewise by increasing its issuance to provide funds for rebuilding. The extra supply of bonds, which will be at least in the order of USD 120 billion over the coming months, will put upward pressure on longer-term yields.

In the meantime, US households are (to use Stephen Roach's elegant but ironic phrasing) "vigorously defending their lifestyles" by indebting themselves still further. There was time just a few months back when the issue was, "Could a country maintain a healthy economy with a household savings rate that was declining towards zero?" That rate has now passed zero and heading deep into negative territory. Moreover, until Katrina, it could be argued that Federal budget discipline was showing signs of returning; that discipline has now disappeared.