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S. Balakrishnan

All signs point to continuing global economic growth, led by China and India, despite surge in energy prices.

FINANCIAL markets are living in extraordinary times.

The US Federal Reserve has been on a relentless march towards higher interest rates, having raised them 25 basis points at every meeting from June 2004.

Yet, yields on 10-year Treasuries have actually dipped below four per cent from close to five per cent. "Don't fight the Fed" is an age-old saying, but the market seems to be paying little heed.

The Fed Chairman, Mr Alan Greenspan, has been scratching his head trying to make sense of the whole thing. He hasn't made much progress since his bewilderment at the "conundrum" of falling long-term interest rates amidst rising short rates. In his latest speech, he says this remains an "unsolved puzzle".

A confirmed bond bear just a few months back, Mr Bill Gross, manager of the world's largest bond fund, now thinks yields could drop further. Morgan Stanley's Mr Stephen Roach agrees.

Reflecting the herd mentality that often characterises markets, many believe the bond rally still has some way to go. The reasons given are many: inflation is and will be tame, thanks to globalisation and ever-vigilant central banks, pension fund buying, continued foreign investment in Treasuries for lack of better alternatives, the need for exporting countries of the Third World to keep their currencies weak relative to the dollar and pessimistic forecasts of an economic slowdown in the coming months.

Is the market right in pushing long-term rates down to such low levels?

True, inflation has barely surfaced despite the surge in energy and commodity prices. But all signs point to continuing global economic growth, led by China and India. Increasing international trade may keep prices down but rising incomes in the Third World will fuel more consumption and investment that will catalyse growth in the G-7 economies as well.

The US is already clocking 3.5 per cent and prospects should soon improve in Europe and Japan.

While borders may not have disappeared, it is also true that there never has been any time in the modern era when trade has been this free.

Ongoing rows on dumping and protection in violation of WTO agreements cannot stop this. Trade fosters competition and keeps prices and inflation low.

Thus, the ballast for bond yields to move up will not be inflation - or the fear of it - but growth and credit demand, which will make non-Government debt more attractive for investors, in turn forcing up yields on Government paper.

We are probably bouncing around close to the bottom as far yields are concerned.

A rise in 10-year Treasuries to the region of 4.5 per cent does not seem all that far off.

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