Bond Outlook September 19th

The essential first aid has been applied, brandy has been given to the victim, who has shown signs of life. Are those signs - the surge in stock markets - really evidence of a full recovery? Alas, no, for the underlying wounds have not been addressed:

• US households must eventually match revenues to expenditure as otherwise this will just be another turn of the wheel before it falls off altogether
• The bubble in housing must continue to deflate, i.e. lower construction activity and lower prices until demand again matches supply

Even the repercussions of these underlying causes, sub-prime failures, CDOs and the credit squeeze, cannot be eliminated by a lower Fed rate, although we dare hope that inter-bank lending will gradually return over the coming months. Whether it does so in time to prevent the US recession that we alluded to last week remains to be seen.

The Fed cannot be blamed for loosening in face of the present threat of recession, any more than the BoE can be condemned for being forced to accept the Government’s orders to bail out savers of Northern Rock.