We have no chance of foreseeing or even properly explaining the swings in equity and bond prices as a function of battlefield news, hope of a quick resolution, acceptance of a long war or rumours linked to Saddam's defiance being read out by someone, not broadcast by the Iraqi leader. There will be a bounce in equities and the dollar (and drop in bond prices) when war ends. There will be anticipation of this, much like sprinters "jumping the gun". Then disappointment will gradually set as reality hit home, viz. that the world's largest economy is on an unsustainable route of ever-increasing indebtedness. The leading adviser to the IMF warns of the fragility of the world economy being beyond the transitory effect of the war, and that ministers meeting at the IMF must not assume that an early end to the war will remove the need for action.

This week, we would focus on likely scenarios as the USA continues to build up internal and external deficits. We have already noted how remarkably similar the two deficits are. Actually, this is not a coincidence, but reflects the equation: private sector surplus = Government deficit - external current deficit. The left hand side is returning to zero (from recent negative levels), so inevitably the deficits are close to each other.

The independent Levy Institute, New York State, extrapolates the two deficits from their current 5% of GDP to 9-10% in 2007/2008, a level inherently insupportable. Therefore, much as we have said so often in this Weekly, something has to give. But what? The solution we have seen since early 2000 (not as policy but as inevitable under economic forces) is a weaker dollar and belt tightening by the US consumer, implying years of poor growth. Now that the dollar has weakened, other countries are not so happy. Thus, as our friends at GNI suggest, Central Banks are intervening to constrain the rise in the euro and Swiss franc. Moreover, the switch that we expected in reserves to a greater proportion of euros has not happened, at least not in Asia. This may reflect a deliberate policy of preventing Asian currencies rising against the dollar. Much like the US Administration's policy of encouraging consumer spending and letting the deficits balloon, there is a sense here of putting off the inevitable. Our concept of reduced dollar-centricity remains in the expectative. In the meantime, the dollar's role as a reserve is still on the increase, allowing and encouraging US economic policies that belong to the world of make-believe. There are plenty of economists in the USA pointing out the issues we deal with here. However, the Administration is quite deaf to their arguments, and the general public has no interest. No rational alternative is being put forward by the Democratic Opposition. In his February address to Congress, Alan Greenspan did not even allude to the balance of payments, despite the recent passage from black to red of the USA's net interest and dividend payments. In fact, that flow will now become a significant and growing component of the negative current deficit.

The Fed and Treasury may however have something approaching a policy to deal with the post-war "return to the normal", anaemic growth. They are borrowing short (2 to 5 years) and, while not actually buying back long, avoiding issuing T-bonds beyond ten years. Normally, this would ring alarm bells for five-year maturities, but the downward pressure on rates should offset the effect. We therefore leave our 5-year recommendation, but are conscious of the need to monitor it carefully.

In the meantime, issuance is at much longer maturities in Europe, and the expectation of a lower yield curve at all maturities may be maintained. Indeed, the strongest trend among our clients (outside trying to follow the influence of the war) is to move gradually from medium-term dollars to longer-term euros.

Unfortunately it is not just in economics that US behaviour seems at odds with reality. The legal system that awards billions to folk who choose to smoke just might be seen as a little bizarre, too. We have to assume that the absurd demand that Philip Morris to post a $12 billion bond before even being allowed to appeal will have to be withdrawn.

Recommended average maturity for bonds in each currency

We maintain our recommendation for maturities in euro to average ten years. Consider our five years USD to be "watchlisted".

EUR/USD: 1.0900/1.0950 is toppish, and support is coming in at 1.0820, 10780 followed by 1.0730.

USD/CHF: 1.3730/50 remains the key pivotal point. After a low slightly under 1.3500, the US unit recovered well in the direction of 1.3700. A weekly close above 1.3750 is needed in order to make more progress on the upside, with 1.3840 as the next resistance.

USD/JPY: Verbal intervention is supporting the USD/JPY between 117.-and 118.--; upside: 119.10, 119.80 and 120.30, followed by 121.00

EUR/JPY: Same comment: broad consolidation in a 125.50 to 129.50 range, coming off the lows and testing the upper side of the range again.

GBP/USD: Key level is at 1.5850. 1.5500 looks well supported, but so long as the rate stays below 1.5850, the pound remains depressed.

USD/CAD: Same comment: since key support at 1.5050 has been broken, the CAD remains one of the market's favourite. The next big support at 1.4650 and 1.4580 . Upside resistance:1.4850 and 1.4930

AUD/USD: Same comment: key level around is 0.5970/0.6000. Below that, the objective is 0.5880, while topside, a weekly close above 0.6000 is needed to generate some renewed buying interest.