Bond Outlook August 6th

The deflation of the commodity bubble, which we called too early six weeks ago, is continuing nicely, and leading to stock market bullishness, reinforced by the Fed’s decision to keep interest rates on hold. The fixed-income market is more cautious, and has every reason to be: the rise in equity markets may be short lived because the very reason the Fed stayed on hold and that commodity prices have fallen is that the economy is in such trouble:

• Whilst Commodity prices (as measured by the S&P GSCI) may have fallen nearly 20% from their peak, they are still 50% higher than one year ago
• US manufacturing industry has no pricing power, but neither does labour, as overtime is eliminated and unemployment rises. Thus both profit margins and household spending power are being squeezed
• The credit crisis is becoming more severe. Households with home equity credit lines may no longer draw on them (never mind obtain new ones). Car leasing has been discontinued or drastically cut back. Indeed, the continued collapse of the US auto industry is as much a credit phenomenon as a reaction to high fuel prices (although high fuel prices do explain the demise of the SUV)
• Retail spending is slowing, although credit cards are allowing households to maintain their spending while running up debt a little longer than we first supposed.