LONDON, 13 October 2003 — Buy boring treasuries and sleep well at night! Definitely a bad joke these days...

The “Sweet Dreams” times definitely came to an end in May, when, after hitting a long-time low, the volatility in the Treasury Market increased to (if not well-beyond) comparable equity levels.

Last Friday the yield on the 10-year US Treasury jumped again by 20 basis points (bps) and Treasuries investors experienced a day like on June 25 when yields surged suddenly by 15 bps or July 15, when bond holders fastened seatbelts for an upwards ride of 25 bps. For once Alan Greenspan cannot be blamed in regards to the latest interest rates rocketing. Rather the recent job market releases were the driver for the roller coasting.

The latest report from the US Labor Department showed September payrolls expanding by 57, 000 jobs for the first time after eight consecutive months of contraction. In addition the unemployment rate remained steady at 6.1 percent.

The equity market reacted euphorically interpreting the reading as the first sign of the long awaited job market recovery, which would address one of the weakest points in the US economy. The bond market reacted violently and sent the yield of the 10-year Treasury up to a level of 4.2 percent

A closer look at the figures, however, causes to furrow one’s brow; what are 57,000 new payrolls compared to the nearly 550,000 job losses in the previous seven months, let alone the number of job cuts the economy lost since March 2001, which amounts to around 3 million? Granted, a positive sign came in from the temporary new jobs creation in the service sector because in the service sector temporary hiring is regarded as a leading indicator for future permanent worker’s needs of companies. But on the other hand the figures for the average weekly hours remained stable at 33.7, signaling no further hiring needs and therefore less than an encouraging message.

The focus which will set the pace in the US bond market in the short term will continue to be in our view the macroeconomic news flow, particularly the job market situation, and the fact that central banks will remain on hold in an expansionary mode. Those factors are going to influence the bond market in a positive way.

From a long term perspective, however, rising inflation expectations, the level of real yields as well as the horrendous current account budget deficit holes will impact the bond market negatively and will cause yields to rise considerably. Our outlook for the short term is for a consolidation with a trading range of the 10-year US Treasury between 4.20 and 4.50 or even a slight drop in yields (4.00) is still possible. Europe is likely to follow the US pattern but with a smaller trading range. From a long-term perspective we forecast higher yields (10 year US Treasury 4.7-5.00) and we consider the short end of the curve (3-4 years) the safest place to be.

In regards to the allocation within bonds we still recommend investing in inflation-linked US securities. Although the break-even inflation level is currently not as attractive as some months ago and in the short-term no big movement from the inflation front is expected, we believe that in a medium to long-term perspective the re-inflationary policy of the central bank will cause inflation to rise and investments in US inflation-linked securities will prove out to be a lucrative investment. Since we first looked at the asset class, TIPS outperformed “normal Treasuries” by 2.6 percent.

Exactly one year ago, in October 2002, the high yields market bottomed out and started a nice rally. After years of rating downgrades and insolvencies the market experienced a veritable revival. Looking at US bonds performance year to date, High yields performed the best (around 25 percent), followed by emerging market debt (approximately 20 percent) Although speed of price appreciation is likely to slow down, high coupons will still provide nice returns. We reiterate our positive view on this bond category.

(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information)

(Habib F. Faris is vice president at Clariden Bank, London.)