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Capital Markets

Bond Outlook October 4th

The key issue to determine soft or hard landing – geopolitics aside – is whether US household gains from cheaper energy will compensate the return to savings as the housing bubble deflates.

Bond Outlook [by bridport & cie, October 4th 2006]

Last week we allowed ourselves a level of optimism almost unique in the history of this Weekly. We predicated our change of view on the decline in oil prices, which, together with the lessening of cost pressure from other commodities and energy sources (notably gas), greatly reduces the danger of stagflation. Stagflation would result from central bankers needing to dampen cost-push inflation through raising interest rates to the point where recession sets in. It is a case of “so far so good”, but the geopolitical situation needs watching in case the “cheaper energy” scenario falls apart because of military action against Iran or even North Korea.

 

It is symbolic that the DJIA reached a new high on the same day that Iran refused to suspend its uranium enrichment and North Korea announced a nuclear bomb test – a case of “temper your optimism with caution”.

 

Another way of describing the grounds for optimism is that “cheap money is here to stay”, not so cheap as to be below the level of inflation, but a healthy one percentage point or so above moderate (2-3%) inflation.

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