Bond Outlook October 25th

October 25, 2006

The great debate goes on: will the next change in the Fed rate, some months off, be up or down? Most of the banks think "down" because the US economy will stall; most of the fund managers think "up" because inflation is still threatening. Either way the stock markets are bullish, be that because they expect lower rates, or because the economy will do so well that higher rates will be required, or, rather, justified for the right reason.

Bond Outlook

October 25^th 2006

Fortunately for investors, there is no urgency in deciding which scenario is correct, as the Fed and just about everyone else sees the need to wait and see, especially to understand the full effect of the deflation of the housing bubble. There is universal agreement that the housing effect is negative, but by how much? One view, expressed this week in the FT, for example, considers how the housing markets in the UK, Australia and Holland made soft landings without damage to their economies. It should therefore be likewise for the USA: prices will merely stabilise overall and the landing will be very gentle. The other view sees the housing market getting much worse, with knock-on effects in employment and in household borrowing power (as we rehearsed in this Weekly a month ago, before energy prices fell). So far, mortgage equity withdrawal has slowed but not stopped. When it does, it will become apparent whether cheaper oil is enough to offset much of the lost spending power based on household debt. Then the key question, "Will the US slowdown denote a recession or merely slower growth?"

All discussion about Fed rate changes and the US housing bubble are about the medium-term.

Bond Outlook October 25th

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