Bond Outlook June 10 2009

We have, in recent days, begun to see a number of the forecasts made in recent Weeklies receive growing support, both through predicted events beginning to transpire, and via similar remarks being made by a number of worthy commentators:

• The intended return of Tarp loans by ten major US banks reinforces our view that the US financial markets are on the mend. Nevertheless, a return to full health cannot be declared until lending to small and medium enterprises resumes
• Long-term rates on T-Bonds are still climbing, with inventories of primary bond dealers running at unusually high levels
• Chinese proposals to create a trading/reserve currency based on the RMB are gathering speed. They have suggested that the USA issues bonds in RMB (!) and have poured scorn on claims by US officials that the US debt situation is ‘satisfactory’
• The deflationary environment can last only so long as the GDP is falling. Once GDP stabilises, we see the return of inflationary risk

In the deflation vs. inflation argument, it is essential to understand the dynamics of the two opposing forces:

• Deflationary forces are at now at their strongest.