Bond Outlook April 4th

April 04, 2007

Are we wrong as equities climb and bonds are not doing much (although USD yield curve is steeping as foreseen)? The real and the financial economy seem out of synch.

Bond Outlook [by bridport & cie, April 4^th 2007]

This week it looks like our warnings about economic fault-lines have proven ill-founded:

So far so good on containment of the sub-prime problems
The yen carry-trade has taken off again
The high-yield currencies are strengthening
Stock markets have recovered many of their losses

On the other hand our expectations of USD weakness and the USD yield curve’s steepening (by a fall in yields at the short end) have proven correct, with the first step being “dis-inversion”, now almost complete between 2 and 10 years. The yield curve is sending signals as confused as anything from the Fed. After a further 2 or 3 months at 5¼ %, will the Fed rate move up to control inflation or down to stimulate the economy? We lean towards the latter despite Bernanke’s warnings, because of what seems to be a decoupling between the finance economy and the industrial economy. Corporate earnings have peaked, industrial activity is slowing, yet stock markets reflect optimism, not least because the continued availability of cheap credit is encouraging acquisitions, private equity and stock buy-backs.