Bond Outlook January 23rd

The Greenspan put continues under new management. The 75 bps cut in the Fed rate on Tuesday slowed the fall of US stocks and gave rise to what seems a temporary rebound in other markets. Whether this will avoid a recession in the USA is a quite different issue. Whenever we address questions about the real economy, we remind themselves of the underlying causes: excessive US spending and the fall in house prices. Can lower interest rates reverse the fall in house prices? We think not because of the excess of supply over demand and tightening credit conditions. Availability of new mortgages is much lower, irrespective of interest rates. Can lower interest costs impact excessive spending? Yes; even if new credit remains hard to come by, a lower cost of existing debt allows households to spend a bit more. The inevitability of an eventual matching of spending to income remains, but the rebalancing process has been slowed by Fed rate cuts. We remain therefore extremely sceptical that the Greenspan put Mark II can do much good for the economy, even if it does bail out the stock market in the short term (which is far from obvious).