Bond and Currency Comment

Our model for bonds and the US dollar recently signaled a change in position to long the US dollar and short the US bond market. Per the chart alongside, you can see performance for the Dynamic Bond/FX Strategy relative to the Lehman Aggregate Bond Index since 12/31/05. We view current dollar and bond positions in the model as tenuous, particularly the long US Dollar bet but choose to stick with the model since it has added value over time. Fundamentally, continued unexpected strength in the economy (such as the Empire State index, which was reported this morning to have risen to 8.0 from 3.8 in April) should have negative implications for bonds as inflation rises (certainly not what was seen in this morning's report with April inflation rising 0.4% versus the consensus estimate of 0.6%, and core inflation up only 0.2%). Meanwhile, housing continues to play out on the downside. Over the short run, we would think this tug-of-war plays out in favor of stronger growth and higher inflation. Nevertheless, we'll stick with the model for our signals.