Bond Outlook March 3rd

Our key question last week was “Is the problem of the sub-prime market already over?” It remains open. Our answer was and continues to be “No”, while financial markets are leaning towards “yes”. There is however plenty of support for our view from commentators, who are more out of step with market views than usual. Many of them question the whole credit-based edifice of the US economy. For example, one opinion is that the effect of the housing bubble may well be cushioned, but, if the lending in dollars (read, “buying T-Bonds and the like”) falls out of favour, the entire US economy will be in deep trouble. Another sees the implosion of sub-prime as only the beginning of a process of unwinding the unsustainable borrowing binge of the last five years.

As it happens, the key basis for our hope that the end of mortgage equity withdrawal (“mewing”) could be absorbed by households, viz., lower oil prices, has suffered a blow this week because of the Iranian capture of Royal Naval personnel.