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To: Les H who wrote (9388)	12/9/2003 10:59:25 PM
From: Les H	Read Replies (1) \| Respond to of 29595

Global Fixed Income Strategy: A Coiled Spring Amy Falls Our message remains the same: We believe that risks are high and rising in the fixed income markets. There is a fundamental tension in the bond market, with the economic recovery and fundamentals supporting a flatter yield curve, whereas the curve is being kept relatively steep by Federal Reserve language and the market's conviction that the Fed is on hold at least through June 2004 (and maybe most of the year given the upcoming presidential election). The most powerful anomaly can be seen between the corporate market and the Treasury market. Our credit strategist Greg Peters and his team have analyzed the relationship between the steepness of the credit curve and the interest-rate market. Looking at historical data tells us that in times of recovery, credit curves typically get steeper and yield curves flatten, with the front end backing up in anticipation of Fed tightening. In the 1993-94 recovery the credit curve steepened sharply, while the Treasury curve flattened dramatically. Currently, we see a comparable steepening in the credit curve, as the corporate bond market believes the economy is healthy, with the recovery on track. We have not seen a comparable flattening in the interest rate curve. Our corporate strategy team's analysis also shows that the two curves are inversely correlated. Using 1993 as an example, we saw a move from a position of steep government curves and flat credit curves to steep credit curves and flat government curves. Today's recovery shows a comparable move in the credit curve but a steeper government curve. There is no question, in my view, that this represents an important anomaly. The point is that the Fed is engineering an excessively steep yield curve in the context of a pretty robust recovery. Risk bets are on, and people are positioned in the front end of the curve. The bond market looks increasingly like a coiled spring, with investors levered to the Fed's virtual promise to stay on hold. I see huge risk in the bond market, and the Fed's exit strategy is very important in this context. I'm not looking for a surprise Fed move in the first quarter of 2004, but the bond market will eventually have to unwind this trade — and it could be messy. morganstanley.com