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Bond Outlook by bridport & cie, March 30 2011

Two major riddles: when will inflation hit the US economy and will quantitative easing be extended beyond June? We suspect QE extension but the inflation issue is a full mystery.

It is amazing, given the high level of uncertainty in the world at the present time, that financial markets are as calm as they are. Whither the Japanese nuclear accident, the Libyan civil war and the Arab Awakening, the Ivory Coast, the euro zone bail-out system, or how will China’s encouragement of higher standards of living in the hinterland alter the terms of international trade and the cost of Chinese products ?


Our focus this week however falls upon the two unresolved riddles of the US economy, inflation and quantitative easing.


We have, in past weeks, expressed our surprise that inflation in the USA remains remarkably and inexplicably low (unless, of course, the statistics are deceptive). Non-dollar imports cost more as the dollar declines, while the prices of dollar-denominated imports - Chinese goods and commodities - have risen substantially. Some say that the absence of inflation is because wages are not rising, but that argument supposes that inflation has to be led by wage increases. We would suggest that raw material and import costs are equal, if not greater, contributory factors, and indeed this would seem to be borne out by the rise in inflation rates elsewhere around the globe.

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