Bond Outlook May 11th

The "slow-motion car crash" of GM, now joined by Ford, moved forward a frame with the downgrading of their bond ratings, or even two frames if you count Kirk Kerkorian's "threat" to sort out GM. The jury is still out on the extent of knock-on effects to Hedge Funds and CDOs (Collateralised Debt Obligations). Our view is that the US economy is fundamentally unhealthy and the debate is not over whether a correction from its over-indebtedness will take place, but when, and whether it will be brutal or gentle. The auto downgrading is precisely the type of event to trigger a turn in market sentiment to bearish, but market resilience has astonished us before, and will probably do so again.

Within our scenario of "something has to give with this double deficit and excess debt", other specific threats could also have a trigger effect:

• The pension fund crisis, exemplified by the United Airlines impasse, may spread. (We call it an "impasse" as the airline says that it has no choice but to default on its pension liabilities, while the unions say they cannot accept this additional sacrifice and threaten to call an industry-wide strike involving all the airlines.)