Monday, November 1, 2010

Fixed Income Outlook

Fixed Income Outlook
  • Rocky Horror Picture Show hurts domestic bond market
  • FOMC meeting with unpredictable options
Rocky Horror Picture Show hurts
domestic bond market
"It's just a jump to the left and then a step to the right. With your hands on your hips, you bring your knees in tight. Then it's a pelvic thrust, that nearly drives you insane, let's do the time warp again".

This describes exactly the battle over a stability pact with teeth. The abandonment of positions and a continuous search for compromise with the risk of losing the hoped-for "teeth" ultimately impacted sentiment towards European government bonds across the board. Furthermore, the bickering over austerity packages in Portugal and the discussion of early elections in Greece are of course poisonous.

ECB rhetoric that increasingly sounds like the central bank is determined to forge ahead with the exit strategy as quickly as possible is also taking its toll.

From a domestic standpoint, the ECB press conference next week is once again of paramount importance. Details on the future timing of the exit strategy will probably be held back until the December meeting, but we see only few chances for "dovish" overtones.

FOMC meeting with risks in all directions
There has been no end to the metaphors. Rogoff compared the US strategy to a bunker shot in golf. What is needed here in his view is an explosion shot – the stronger the better.

Whether you overshoot the green is irrelevant, the main thing is that you are out of the bunker. Using a turkey Thanksgiving analogy in an article entitled "Run Turkey Run", Bill Gross espoused the view that - one way or another - the FOMC announcement on Wednesday will mark the final turning point at the long end.

But what is more important than a volume of USD 400 or 600bn is the message between the lines. If investors conclude that the US central bank will continue this program doggedly until, for example, an annual rate of change in the core deflator of 2% or higher is reached, the reaction is likely to be positive.

There is reason to doubt whether there will already be such a commitment in the current situation where FOMC members are in some cases espousing diametrically opposing views.

Overall, there is the fear that the current rise in yields at the long end in the euro zone is not over yet. Money market rates will probably continue their extensively linear path in the direction of 1.2%, irrespective of the QE2 decision in the US.

Full report: Fixed Income Outlook

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