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Bond Outlook October 14 2009

Some investors see credit and inflation risk so high that capital protection is their main preoccupation; others see the rewards of low-credit bonds continuing for some months. Who is right?

Bond Outlook [by bridport & cie, October 14th 2009]

The search for yield versus a flight to quality; that is the choice facing fixed-income investors, and there can be no doubt that the former has been the more successful in recent months. It is a situation that cannot last indefinitely but probably has some months of life left in it. The turning point will probably correspond to the shift that we expect from a deflationary to an inflationary environment, or at least to yield-curve steepening. That still seems far off, but within a time horizon measured in months rather than years. Are we self-contradictory in seeing curve steepening months away but a flat GDP in advanced economies lasting years? We would be if it were not for the need for governments to borrow extensively and unwind their quantitative easing.

Our proposal in favour of index-linked bonds is now a widespread recommendation, although it comes with the warning that if the current deflationary environment lasts much longer than we expect, ?linkers? will perform badly. The Fed is committed to preventing inflation from ?surging too high?.

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