Figuring Out the Bond Market When History Doesn't Apply

Two weeks ago, I was preparing nifty-looking charts to offer some perspective on our economic situation relative to past cycles. However, the world has changed in innumerable ways, and comparisons to the past might not be that useful. For example, there's increased potential for U.S. military engagement in the Middle East, yet oil prices aren't skyrocketing. This contrasts markedly with the months before the Gulf War, as crude jumped from around $20 per barrel to around $40 in August 1990.

While it's difficult to compare this environment to the past, it's also hard to make judgments about the future. Of course, the virtual shutdown of significant parts of the economy for two weeks has had a negative impact on the economy. That's a given. The key questions are how deep it will be and how quickly and strongly we will rebound.

It's impossible to respond to those questions now. The answers will partly depend on the global response to terrorism and on whether domestic travel patterns pick up. These are two factors without much historical precedent. While predicting the economy is now even harder than usual, we can try to figure out what outcomes markets are discounting and, from that, get an idea of what the potential risks and returns are. ...