Bond Outlook March 14th

The pause in the market correction did not last very long. In fact, for equity markets, this is looking remarkably like a “dead cat bounce”.

We have long held that the dominant issue facing the US economy was the end of the housing bubble. The JPY carry trade is also important, but a secondary issue while the housing market works through its problems. We had supposed a simple linkage between mortgage equity withdrawal (“mewing”) and consumer spending:

• US households spend more than they earn
• most of their borrowing is against increased home equity
• house prices have stopped climbing
• ergo, mewing must cease
• spending must decline
• GDP, so dependent on retail consumption, must also decline
• additional consequences include a weaker USD and an improved balance of trade

We envisaged this as an essentially middle-class phenomenon, in that the cracks would first appear in the spending capacity of financially solid households. In fact the first cracks, now huge crevasses, have appeared in the sub-prime market, i.e.