Bond Outlook March 4th

Maybe we relish the role of a voice crying in the wilderness. In the days of the Goldilocks economy we warned that the unsustainable had to end. Now, when almost every commentator and piece of news is black, we feel bound to look for chinks of light. Yet it has undeniably been a week of growing darkness:

• Stock market lows
• House prices declining still further
• Talk of default in Eastern Europe and even amongst euro-zone countries
• AIG announcing record quarterly losses (and Bernanke criticising them publicly)
• European banks more leveraged, and therefore exposed, than US banks because the Basel Accords allow weighting of assets whereas US banks still have a simple equity to asset ratio (10%) – not that US banks provide a good example of prudence!
• The automotive industry threatening plant closures
• Such an increase in money supply in the USA that inflationary forces could completely overcome the deflation risk

Light piercing the gloom is indeed hard to find, but we some see in:

• The ability of certain large corporations to raise funds through bond issues
• A plan by the Obama Administration to reduce foreclosures, a step towards stabilising house prices, which is in turn fundamental to stopping the decline in economic activity
• China announcing a new stimulus package for domestic demand (USD 585 billion)

It is not much, but it allows us to cling to the hope that the downward leg of the L-shaped recession will be over by the end of this year, although not so early as the end of the summer as we had thought.