Bond Outlook October 24th

Just as last week we had to present both sides of the inflation vs. deflation argument, and can only wait for a definitive answer, so this week the sense of “wait and see” continues. Our tentative answers to several key questions are in italics:

• Will the Fed cut rates next week? If it does, is the implied USD weakness priced in or will the USD fall still further? Yes, but we still believe the bottom is not yet in sight.
• Will the combined weight of a drop in housing wealth and poor income growth finally slow US household spending? Yes, but the spend-spend mentality is remarkably resistant, so the impact may not be immediate!
• Have all the CDO losses and the losers been identified? We fear not. AIG may have spoken up, but many insurers (for example) are saying little.
• Will the rest of the world cope with a US slowdown? If a mere slowdown as we suspect, yes, but if a real recession, everyone will suffer.
• Has the banking liquidity problem been solved? To judge from our experience in bond execution, things are slowly getting back to normal, however, bank risk appetite will be lower than prior to the credit crunch, which will have an affect on growth.