Bond Outlook June 21st

The question that we raised last week remains fundamental to investor strategy in fixed income: are equity markets at the beginning of an extended bear phase or not? Our supposition is that they are, from which we draw the conclusion that long-term bond yields will rise but little, and a degree of barbelling is appropriate as central banks continue to raise rates. Indeed, it is the continued removal of liquidity throughout the world that is the cause of the flight to safety. There is consensus among the central banks; this is not just a case of “follow the leader”. Rebalancing the world’s economy is firmly on the agreed agenda of all financial and monetary authorities, which includes:

• A reduction in the USA’s relative consumption of the world’s output
• A managed decline of the USD
• A slowing of China’s growth and a shift to domestic consumption
• Improved domestic consumption just about everywhere to compensate for the relative decline in the USA
• Higher interest rates in Japan, sharply reducing the attraction of the carry trade

The US contribution to this rebalancing is led by Fed Chairman Bernanke, but he has to act almost surreptitiously in the light of an Administration policy of growth without regard to deficits.