Jeremy Warner's Outlook: The doomsters seem to be wrong again as normal service is resumed in bond markets

Massacre on broadband street; End of the line for British aerospace
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The Independent Online

Yesterday brought a slight reprieve in the bond market sell-off - prices move inversely to yields. None the less, few expect the 10-year note to be trading at any less than 5 per cent by the end of the week. The 30-year bond is already above that level.

The past year has been steeped in rare phenomena for bond markets. Only a while back, analysts were still trying to come to terms with a sudden inversion in the yield curve, where long bonds come to yield less than short-term interest rates. Many took this as a sign of impending recession. Now the very reverse perception has taken hold. Sharply rising long-bond yields, indicating as they do that investors see a greater risk of inflation, point to the persistence of strong growth.

Going a little further back, Alan Greenspan, then still chairman of the US Federal Reserve, referred to exceptionally low long-bond yields at a time when short-term interest rates were moving higher as a "conundrum".

That conundrum is today relatively easily explained. The extraordinarily loose monetary conditions brought about by the Fed in the wake of the September 11 terrorist attacks prompted a scramble for yield, forcing investors out along the yield curve in their search for income. What was going on was just a simplistic version of the "carry trade", where investors were able to borrow at depressed short rates and lend at higher longer dated ones.

The situation was exacerbated by heavy buying from Asian central banks accumulating dollar currency reserves, and by the Opec countries looking for a home for their petro-dollar billions. As the era of excessively cheap money draws to a close, the reverse process has set in.

In many ways, this is precisely what you would expect for this stage of the cycle. Even so, the speed and strength of the rebound in yields has caught many by surprise. Conventional wisdom was that the US economy would be faltering by the end of the year. Few now hold that view.

The inverse yield curve has gone, while the relationship between short and long-term rates is fast being restored to a more normal footing. Among the Asian central banks, all but China have stopped buying dollar assets. And while demand has eased, supply has greatly increased, not just from governments looking to finance their deficits, but from corporations too seeking to raise money in the debt markets to finance increased investment.

These generalisations on supply and demand are only a proxy for the wider picture, which is that the world economy is continuing to expand a great deal faster than investors were expecting.

Contrary to forecasts, higher US interest rates and a decelerating housing market have not yet caused the wider US economy to slow markedly. The labour market, particularly at the skilled end of the spectrum, remains as tight as tight can be. There is little reason to doubt any longer the Fed's long held view that short term rates may need to go higher yet before they peak out. Only a fool would now attempt to predict where and when the present cycle might end.

As in the UK, house prices and consumption have proved less interest rate sensitive than commentators thought. Like Mr Greenspan's conundrum over long term interest rates, the phenomenon is easily explained with the benefit of hindsight.

With strong economic growth, demand for skilled labour, now more than half the workforce in the US, has continued to grow to reach a self sustaining pace which appears immune to the usual influences of monetary policy. As in Britain, onerous building regulations in areas where skilled labour is most in demand is continuing to force the price of housing up. As mortgages become more expensive, employees simply demand more pay, which leads to inflationary bottlenecks in key areas of the economy.

No wonder Ben Bernanke, the new chairman of the Fed, shows so few signs of abandoning his predecessor's campaign to raise rates. And no wonder too that long rates have been climbing even more steeply. Yet again, those predicting a recession, or rather a sharp slowdown, have been proved wrong. Their day will eventually come, I guess. It always does. But not quite yet.

Massacre on broadband street

You would have thought the telecoms industry had learned its lesson from the boom and bust of the dot.com bubble, but apparently not. Its propensity to turn scarcity into glut seems destined to repeat itself all over again in the present landgrab for broadband customers.

Prices are already tumbling - witness today's expected announcement from Carphone Warehouse of three months of free access - and we now have the almost farcical spectacle of Carphone, Bulldog, Tiscali, AOL, Yahoo!, BSkyB, Pipex, Plusnet, Uncle Tom Cobleigh and all scrambling to install their own local loop unbundling (LLU) equipment in British Telecom exchanges.

It scarcely needs saying that not all of them can be winners. Indeed, BT's prediction that the market will eventually settle at no more than four players may not be too wide of the mark. Carnage can confidently be predicted in getting from here to there. With prices falling faster than new customers can be signed up, few seem destined to make any money out of the present madness, not in any case until the market starts to consolidate.

One of those few might be Carphone, which has three key advantages over rivals. One is that through Opel it already has its own, extensively developed, leased line network, which enables a particularly low cost service. Another is that it also has 2.5 million TalkTalk customers, who make a captive customer base for the company's broadband offering. A third is the distribution network offered through Carphone itself, which again ought significantly to reduce the costs of customer acquisition.

One distinguishing feature that Carphone lacks is content, but few yet are able to offer anything compelling on this front. For the time being, the landgrab is only about the commodity product of broadband access itself. By bundling this with pay-TV, voice and the soon to be acquired Virgin Mobile, the cable company NTL hopes to offer a further point of differentiation, but it only really works if one of these services is essentially thrown in for free.

How long before the first in this jostling pack of broadband competitors retires hurt? Not long by the look of it.

End of the line for British aerospace

Whenever I write about football and aerospace, Boys Own subjects about which I know little, I find myself in trouble. So I should have taken a little more care in referring to the de Havilland Comet as the world's first commercial aircraft in a piece in Saturday's Outlook about BAE Systems' sale of its stake in Airbus. It was, of course, the world's first commercial jet aircraft. Commercial aircraft travel predated the Comet by at least 30 years.

My mistake none the less highlights an interesting phenomenon. Judging by the number of e-mails I received, Britain is still reassuringly filled with those who care deeply about our country's industrial heritage in aerospace.

Cheerleader though I might be for the post industrial success story Britain has become, I cannot help but share their dismay at our retreat from civil aircraft manufacture. It is simply not credible that that our long-term future in this industry will survive the passage of the BAE stake to the Franco-German combine that owns the rest of Airbus. Were it not for the 15 per cent limit placed on overseas holdings, reinforced by a golden share, it surely wouldn't be long before Rolls-Royce too found itself answering to foreign masters.

j.warner@independent.co.uk

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