The Fed rate cut may have been justified, but it does not solve deep-seated problems, notably falling house prices. But at least serious rebalancing of the world's economy is underway.

Bernanke has put sticking plaster on the wound, a necessary but insufficient move. The problems of overspending and housing remain, and the immediate credit crisis has yet to be solved.

The US economy is slowing because of the sub-prime failures, but, as central banks fail to solve the bank liquidity crisis, the credit squeeze will amplify the effect. Recession?

While the Fed is focusing on solving the credit squeeze, any target rate cut this month will be to avoid a recession resulting from the bursting of the housing bubble.

A systems failure means the system must change. Consider how, and follow through the logic of the housing bubble busting, the credit squeeze and the carry trade.

Bank liquidity is the single main problem the US policy makers should focus on. Only T-Bills are wanted when banks will neither lend to each other nor trade commercial paper.

Even as financial markets almost beg Bernanke to bail them out with a cut in rates, he continues to stress inflationary fears, which seem quite justified as China’s prices rise.

A major step to world rebalancing has taken place with credit markets reflecting a more appropriate risk/reward relationship. We would see Bernanke accepting a slower US growth as desirable.

Credit markets remain more alert to dangers of CDOs and the credit squeeze than equity markets, but if the tail strikes, too, watch out! We mean carry-trade unwind.

It is right to focus on sub-prime related CDOs, but the de facto credit squeeze, with wider spreads and more severe terms for corporate loans will have even wider negative repercussions.

Systemic failure by the US financial system is tacitly admitted by the Fed “pilot scheme: on mortgage supervision, but is also apparent in the absence of market prices for CDOs.

The sub-prime/CDO crisis is not just about “knock-on effects” as risk aversion grows, but is a sign of systemic failure by the US financial system. Expect serious pressure to reform.

Sub-prime and CDO problems are just not going away, despite attempts of banks, rating agencies and regulatory authorities to pretend otherwise. Odd that the UK’s FSA should speak up, though.

Bond Outlook [by bridport & cie, June 27th 2007]

The shift of foreign purchases from US T-Bonds to other bonds and equities reflects government decisions about reserve management. Normalisation of the USD yield curve will have serious repercussions.

The USD vulnerability we expected has not happened but bonds and stocks have proven very sensitive to higher yields. We offer our explanation in terms of surplus countries’ investments.

Bond yields moving towards higher levels spells out a new environment in which good returns from bonds and shares will be hard to come by. Watch for further USD vulnerability.

Switzerland is enjoying a cheap currency, a property boom and expanding labour. We draw parallels with Spain, UK and Japan and seek a general conclusion about labourforces everywhere.

While the Fed may be worrying about excess cheap credit, the Chinese may be doing something about it as they divert some of their investments to private equity.

As if a housing bubble were not enough, a new one is inflating in junk bonds linked to LBOs. 1989s revisited? Even “toggle bonds”, a new name for “bunny bonds”.

The housing bubble deflation pushing toward a Fed rate decrease, and the tight labour conditions still threatening inflation and a Fed increase. Which will win the “race”?

An asset bubble on a global scale? What happens when it ends? How do investors prepare for its end? Seek matching risk and return while decreasing overall risk?

We keep insisting on sub-prime problems still to come. USD 75 billion may be the loss to date for buyers of opaque and illiquid US mortgage-backed bonds.

The news this week, including a still weaker USD and a politico-economic rapprochement of China and Japan, suggest global rebalancing is advancing nicely. US household consumption has yet to moderate.

Moody's Investors Service cut the credit ratings of 44 banks, including units of ABN Amro Holding NV, ING Groep NV and Fortis, as it seeks to calm protests over a new system for assessing financial institutions.

The sub-prime problems are spreading and will eventually wash through to consumer spending, but good news that a weaker USD is really helping US exports, while Europe is holding its own.

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, March 21st 2007]

Cracks in the sub-prime mortgage market have turned into crevasses, and cracks are appearing all over the housing loan business. First reaction of the authorities? Mutual blame!

The market correction is not over, as the root causes, housing and carry-trade, remain. A slowdown in the USA means interest rates, except in Japan, at or near their peaks.