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Bond Outlook
[by bridport & cie, October 2nd 2002]
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Dear Readers, |
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So we have been "Austrian" all along! After fifty years of being
ignored, the economists of the last years of the Austro-Hungarian Empire,
most of whom ended up in the USA, are again à la mode. In amongst all
their arguments about the relations between individuals and society and
the superiority of the free-market system over central planning, lies the
gem that easy credit, combined with increased expectations of profits,
leads to over-investment and excess production capacity. This tendency is
encouraged by low inflation, which in turns removes the incentive for
Central Banks to raise interest rates. Indeed, the Banks have been told by
politicians to focus on inflation rates, with a sideways glance (in the
case of the Fed) at overheating. It is therefore scarcely surprising that
they ignored the issue of over-investment, and, even if they had tried to
prevent it, political opposition would have overwhelmed
them. |
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As we (and others) have pointed out in recent weeks, the Central
Bankers are fighting yesterday's war against inflation instead of today's
battle against deflation. They play according to the rules of modified
Keynesianism, which has worked well when excessive demand created
inflation and insufficient demand recession. Now, just as the wrong type
of snow stopped trains running in the UK a few years back, this is the
wrong type of recession. The recipe of ever looser money supply, as in
Japan, cannot turn an economy round because corporations cannot do
anything useful with new funds. Consumers and the Government can use new
funds, but the productive side of the economy cannot. |
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Many corporate bond offerings have been withdrawn recently. At
first sight, this might mean that the demand is inadequate at the spreads
offered and that corporations cannot afford to pay more. True. Consider,
however, that there have been fewer corporate bond offerings this year,
and that the recent cancellations suggest no particular need for new
money. HP, for example, cited market conditions, but added that the
company has no urgent financing needs. Of course not! At a macro-economic
level, corporate borrowing must fall from its current 42% of GDP (for
non-financials). At the micro-economic level, cleaning up balance sheets
and refraining from unproductive investments is driving most
companies. |
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Only one thing can solve the problems of the laxity of the US
Administration and the Fed, viz., time. Time to allow savings to recover,
the balance of trade to improve and asset values to return to long-term
trends. Time will however work its magic better if, in addition, the
dollar is allowed to weaken enough to improve the balance of
trade. |
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Meanwhile in Europe, Governments rival the Japanese for their
inaction. Nevertheless, we admire the new taxation system being introduced
by Italy, where income tax now works as follows: earnings are deposited in
Swiss banks and sit there making modest returns in CHF for a few years. In
due course, the owners are granted an amnesty. The old money returns to
the Italian economy and the whole cycle begins again. Net result: income
tax of between 2½ and 4%… |
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The confusion created by stock market volatility and hopes that a
bottom has been found have repercussions on bond strategy and prices. Our
clients have indeed been pulling in different directions. Some perceive
bonds as overbought and have begun profit taking. Others believe more in
waiting till a much more solid bottom is built for the stock markets. If
there is a trend, it is from financial corporate bonds to
non-financial. |
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Our view has been and still is that the fundamentals are against
economic recovery (e.g. still rising unemployment, contracting
manufacture, declining profits, excessive indebtedness). It is hard to
imagine a stock market moving in the opposite direction of the
fundamentals when valuations as a function of earnings and their outlook
are still so high. Add to that the wrong diagnosis of the governments, and
conclusions of the "Austrians" is incontrovertible: a recession is an
unavoidable, but necessary evil. |
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The American consumers remain heroic is in their endless spending.
How sad that the air they are all the time blowing into the economy is not
only leaking but also preventing the cure needed for durable
recovery. |
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In the smaller world of European bonds, the attraction of Norway
and its currency, already apparent for many weeks, remains strong. The
reach of Baghdad via oil prices is a long one! |
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Recommended average maturity for bonds in each
currency.
Remain long across the board, except in
Sterling |
| Currency: |
USD |
GBP |
EUR |
CHF |
| As of
10.07.02 |
2012 |
2007 |
2012 |
2012 |
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The FOMC and the BoJ decided to leave interest rates unchanged, the
ECB continues to think monetary policy as being adequate, and all this in
a still very weak economic environment. However, the SNB made it very
clear that, if the CHF should continue to strengthen, some extraordinary
measures will be applied. (negative short term interest rates or, in
extreme situations, open market currency intervention). The most likely
outcome in the weeks ahead is for continued range trading. Market
participants are getting excited each time at the top or at the bottom,
finally hoping for a break out. All recent comments on the various
currency pairs remain valid. |
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EUR/USD: A broad trading range of
0.9580/0.9610 and 0.9980/1.0020 still looks valid. A clear break on either
side would be good for at least 150 to 200 points. |
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USD/CHF: Here, it looks like that
the market has some interest to buy USD around 1.4700 and to sell them
between 1.5250 and 1.5330. Only a clear break on either side would open
the door for a move of at least 200 points. |
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USD/JPY: The 120.30/50 is becoming
major support, and any break would again speak for the old trading range
of 115.50 to 120.00. As stated last week, the 123.50 to 124.00 zone is
acting as strong resistance, with major selling interest by the export
community. |
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EUR/JPY: The market finally managed to
break the 119.60 resistance zone and confirmed the break out from its old
trading range of 115.50 to 119.50. However, the air is getting thin above
122.00 and most probably some consolidation will be seen between 120.00
and 122.00. |
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USD/CAD: The CAD continues
its weak behaviour as it seeks to establish itself above the support of
1.5780 but still eyeing the 1.6000 area. We prefer to wait to establish
our long CAD short USD position until we have a clearer view of how the US
is going to perform economically. |
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AUD/USD: Same comment: it looks like
that the Aussie is still struggling to sustain levels above 0.5500 for
very long. Consolidation in a 0.5350 to 0.5550 range is to be expected
until further notice. |
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USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
| Resistance/Breakout |
1.5010 |
0.9880 |
1.4730 |
123.20 |
121.80 |
| Current spot
level |
1.4870 |
0.9825 |
1.4620 |
122.85 |
120.85 |
| Support/Breakout |
1.4780 |
0.9730 |
1.4550 |
121.80 |
119.60 |
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AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
| Resistance/Breakout |
0.5550 |
0.4780 |
1.5850 |
1.5750 |
323.00 |
| Current spot
level |
0.5445 |
0.4750 |
1.5835 |
1.5650 |
320.50 |
| Support/Breakout |
0.5350 |
0.4680 |
1.5780 |
1.5550 |
313.50 |
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