Income Strategy October 12, 2007:

The bond markets in North America have generally calmed down over the past couple of weeks it seems that investors have shrugged off the damage that the sub-prime mortgage market blow up is going to have on the economy.

It seems to me that the market has become a little too complacent in regards to the potential fall out from the real estate slowdown and mortgage problems that  are just starting an extended cycle of disappointments. The number of new homes being built in the US is falling but the inventory of new homes for sale has been rising indicating a reluctance on buyers to step in to the market at current prices. Until the inventory of new homes stabilizes or starts to decline prices of new homes will continue to fall unless lenders return to a less restrictive lending policy and that is not likely to happen any time soon.

The Federal Reserve has started on a trend to lower rates these changes in direction are not to be taken lightly. History would suggest that once the Fed changes direction it will stay the course for an extended period of time, bringing rates much lower than they are at the moment.

The Bank of Canada on the other hand is likely to leave rates at the current level for a while longer as the Canadian dollar strengthens in value the stronger currency tends to act like a rate increase on the economy. The Bank of Canada will only resort to an increase in interest rates if there is a surge in inflation which needs to be contained. The next move for interest rates in Canada will be down but it is not likely to be in the very near future unless the Asset Backed Corporate Paper sector becomes even more troubling that it is at the moment.

Investors should remain invested in shorter term instruments which will be less risk over the next year or so. Stay with Government issued bonds as there is a considerable amount of uncertainty in the corporate sector, where yields are elevated but unless you know for certain what the risk is it is not likely to be an easy investment to hold as volatility will be much higher.