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Bond Outlook February 17 2010

The bond market went quiet last week because of lost working days. The issue of liquidity may be temporarily resolved, but next week will determine if normality has returned.

A week truncated by various holidays has meant that bond markets have been operating at lower volumes with fewer new issues (not least because many have been pulled), for which liquidity has again been sufficient. Whether the reduction of liquidity, identified last week, returns will be seen over the coming days. In the meantime, apparently contradictory headlines "Foreign demand falls for Treasuries" and "Investors rush to quit junk bonds" imply a search for safety in the only place left: high-quality corporates.

There has been a parallel pause in forex movements. A cynical view (like ours) is that the relative strength of the USD and the EUR depends on which of both troubled currencies is perceived to be the weaker. For the EUR, Greece is an enormous problem, far from resolved, while for the USD doubts about the recovery are re-emerging. Voices as respected as Rogoff's of Harvard and Hoenig's of the Kansas Fed are stressing that printing money inevitably leads to inflation and low growth. In parallel both MSI and economists from Dartmouth and Santa Cruz claim that only inflation can achieve a return to a normal ratio of Federal debt to GDP.

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