Bond Outlook March 19th

The Fed is getting very good at turning round sentiment for equity markets, but our scepticism remains as to whether the latest cut in the Fed rate, together with opening the discount window to non-banks, addresses the basic problems of a deficit economy, falling house prices and overuse of leverage. In fact, nothing has changed: the US authorities have decided to return to their old standby of cheap money, while paying no more than lip service to inflation. Most other economies have central banks which are still serious about inflation and will delay taking the path of the Fed for as long as possible. Even the BoE, which has presided over a GBP falling almost as much as the USD, is announcing that “holding down inflation is the absolute key”. There is only one way to control inflation with a weak currency: keep interest rates high and accept an economic slowdown. The alternative of lowering the rates can only accelerate a currency’s fall and associated inflation. Yet that is precisely the Fed policy!

We have recommended long maturities in USD and EUR on the grounds that recessionary pressures, including low short-term yield (which tend to keep long-term yields down), outweigh inflationary pressures (which push them up).