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Bond Outlook by bridport & cie, November 3rd 2010

Constipation may better describe the situation of the US economy than champagne cascades, and the risk investors face is that relief may come in too big a dose!

Bond Outlook [by bridport & cie, November 3rd 2010]

The US economy is, for want of a better word, constipated. The image may not be as attractive as our previous champagne cascade metaphor, but it aptly describes how liquidity is stuck within banks and corporations, but is failing to trickle down further into the economy in the form of spending, investment and property purchases. With QE2, the Fed is forcing cash in at one end in the hope that it comes out at the other. This represents a double risk, in that the strategy may not work at all, or that it may work all too well. If the cash build-up floods into the economy at large, inflation will be let out of its cage, and the yield curve will steepen dramatically. The curve is already steepening as the Fed’s anchoring of the overnight rate, and its intervention at longer maturities, are no longer forcing yields down. As many commentators have observed, a Keynesian treatment was entirely appropriate in avoiding a depression in 2008, but is no longer the right approach to encourage stronger growth when a degree of stability has returned.

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