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Bond Outlook January 6 2010

With so much positive sentiment reflecting the assumption of a “normal” recovery, there is reason for caution. Government borrowing needs will increase interest rates in the USA and UK.

Bond Outlook [by bridport & cie, January 6th 2010]

In these opening days of 2010, there is positive prevailing sentiment in the financial markets, based apparently on optimism that a normal recovery is underway. That would imply expanding demand, increasing output and decreasing unemployment. For the world as a whole, this optimistic mood appears justified, not so however for the USA, UK and Japan, where government indebtedness is a millstone around the neck of the economy.

Unlike many commentators, we cannot see Japan as a “model” for what is to happen in the USA and UK. The continued trade surplus of Japan and massive domestic savings, which fund the government deficit, are key differences. The USA and UK still need funding from foreigners to sustain their internal and external deficits. To return to an old theme of ours, China still holds the strings for the exchange rate of the USD and, by extension, US interest rates.

The only comment we would make on the UK at present is the development of the strange situation of having a government which is almost certain to lose power by June 2010, but which cannot resist the temptation to be irresponsible in these last months of its life in the hope of reversing the tide of political sentiment.

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