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Bond Outlook August 15th

Even as financial markets almost beg Bernanke to bail them out with a cut in rates, he continues to stress inflationary fears, which seem quite justified as China’s prices rise.

Bond Outlook [by bridport & cie, August 15th 2007]

Central banks have proven apt at providing liquidity to push the overnight rates in their various jurisdictions back down to the target rates. However, that is only to confirm that they are making effective use of the one tool at their disposal – control of overnight rates. For the rest, “control” belongs to the market, and the market is unhappy precisely because prices of everything associated with the word “mortgage” are unclear and exactly who holds what distressed securities is unknown. Obviously hedge funds are no longer the flavour of the month and today, the last day for the six-week notice period for withdrawal at the end of the current quarter, is likely to see major requests for withdrawals at end September. That will in turn lead to continued forced sales and to further unwinding of the carry trade. The sea change in credits markets which we described last week still has some weeks to settle down.

Intervention by central banks by providing liquidity at the overnight rates, i.e. without penalty, is open to the criticism of creating moral hazard.

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