Bond Outlook September 6th
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Bond Outlook September 6th

We consider four economic scenarios ranging from “Goldilocks” to “Catastrophe”, and argue for the one we favour (a fairly soft landing), while admitting a risk of something worse.

Bond Outlook [by bridport & cie, September 6th 2006]

The questions we have raised in recent weeks reflect the great incertitude and broad range of opinion on whither the US and the world economy. Although possible outlooks really fall on a continuous spectrum, we count four scenarios receiving support from various parts of the investing community:

 

  1. “Goldilocks”: a US economy which is neither too hot nor too cold – basically a continuation of the recent years with households still spending and foreigners supplying the capital to cover the current account deficit.
  2. A mild slowdown: a reduction in mortgage equity withdrawal slows growth without quite conquering inflation. However, the US economy is able to withstand the required further interest rate rises. Consumers in Europe, Japan and in the developing world compensate the modest slowdown in US consumption.
  3. A recession: US households reduce spending drastically and turn to saving. Inflation is still not conquered, but the Fed dare not raise rates further, preferring stagflation over a worsening recession. The knock-on effect is global as consumers elsewhere cannot sufficiently increase their spending.
  4. A catastrophe: the dollar collapses under the weight of the deficit or because of external events linked to the Middle East.
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