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Will the credit rally stick?

When everyone agrees everything’s alright, we’ve a classic sign of a bubble.

Talk to credit market participants about the rally of 2009 and many make tongue-in-cheek references to a certain kind of primate, who, had it had access to funds under management and a telephone, could have reaped rich rewards this year as well. The potent combination of severe market dislocation in 2008 and heavy doses of central bank liquidity administered in its wake has conspired to crush credit spreads and revive positive market sentiment. As the year draws to a close what’s perhaps more surprising is that more money hasn’t been taken off the table. One would typically expect the rally to stall as trading desks and investors lock in profits. The evidence of that is scant.

At a credit conference hosted by Citigroup in London last month a straw poll of several hundred investors at one particular session revealed why. When the audience was asked if they thought credit spreads would be significantly wider in 2010, just two investors raised their hands. Whether or not this rally can be classified as a bubble is open to debate, but one of its classic traits is already prevalent: overriding consensus among market participants.

The two things fixed income investors fear the most in 2010 is the threat that central banks may withdraw their liquidity support from the market and an outbreak of inflation.

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