Expected Inflation

We've recently had considerable hand-wringing in the press regarding inflation expectations. One of the best measures of inflation expectations is the spread between the 10-year T-note yield and the 10-year Tips yield. While both indexes have risen since the beginning of the year, the spread has actually declined from previous highs: last week the spread was 2.59% versus prior peaks in second quarter of 2005 and mid-2004 of around 2.8%. It has also declined from the 2.72% level of a month ago.

With real estate dramatically slowing, consumer spending coming in under expectations and inventories rising we think inflation will not be a concern.

Strategy Update: We continue to be slightly long the US dollar in the Dynamic Fx Strategy. Our initial entry on the long side of the dollar was due to the extreme consensus of sentiment that one should be short the dollar, in addition to some fundamental reasons to expect a pause in the weakening. We continue to believe that a short dollar position is inevitable over the next several years - hence, the only small exposure to the long side. This strategy is designed to provide intermediate bond yields enhanced by exposure to either long the dollar or short the dollar using the US Dollar index.