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Bond Outlook August 3rd

More rises in the USD yield curve is resulting from RMB unpegging. Rebalancing has now started and but needs the US housing bubble to deflate to cut excess consumer spending.

Bond Outlook [by bridport & cie, August 3rd 2005]

A fortnight ago, in response to our own question about whither US inflation and yields, we came down in favour of believing that both would climb. The subsequent unpegging of the RMB rather reinforces that view. Of course the 2.1% revaluation in itself is negligible, except that is likely to be the first of many such small steps in coming months. Then higher import prices will begin to weigh on US inflation. Yet it is the secondary effect of the unpegging that we see as of greater import. The shift to an undefined "basket" implies a corresponding shift in the mix of reserves, or at least in the mix of new reserves. This translates to smaller demand from China for US T-Bonds, and not only from China, as at least South Korea and Malaysia are following China's example. Smaller demand means higher yields.


Whether fortuitous or the result of extremely astute planning, the Chinese have chosen a propitious moment for softening the impact of their unpegging. The improved (meaning less dire) US fiscal deficit means that the Treasury is cutting back on its issuance.

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