Bond Outlook December 16 2009

The year approaches its end with investors feeling satisfaction, and no doubt some relief, over their portfolio performance, but with lingering concerns about the economic outlook for 2010. There is indeed so much to worry about that it is hard to identify the greatest concern from a list including government indebtedness, unrecognised bad loans on the books of banks on both sides of the Atlantic, possible bubbles in gold, stocks and high-yield bonds, growing unemployment, increased currency volatility and the likely impact of a putative Copenhagen agreement on climate protection.

We have already dealt at length with government indebtedness and the end of the stimulus packages, including quantitative easing. We see no alternative to a steepening yield curve later in 2010, except a double dip recession, which is difficult to countenance. Central banks, especially the Fed, have to time their exit strategy perfectly, and choose the right mix of short vs. long term tightening. It is of course a new concept that the Fed can influence long-term rates directly by selling their government and agency bonds in competition with the Treasury’s own issues.