Bond Outlook [by bridport & cie, June 4th 2003]

The political game of talking up the economy continues against the background of a "successful" G8. Greenspan admires the "appropriate timing" of US tax cuts, while, in the same breath, warning of future problems of the deficit! He says deflation is unlikely, but is taking measures to counter it, just in case. Duisenberg explains that the strong euro is merely back to historical averages and that lower cost imports will stimulate domestic consumption. The US Administration is still trying to maintain consumer confidence and spending. The result is a significant stock market recovery, which itself is used to justify the affirmation that the underlying economy is recovering. The only problem is that it is not.


Our pessimistic, sceptical side says that all this is political nonsense, with a short-term focus in the USA aimed at re-election of George W. The only way to keep some economic growth on both sides of the Atlantic is to cut rates still further. Yet even this weapon is countered by increasing unemployment and incipient deflation of the housing bubble. The new stock market bubble (trailing PEs back up to 34 on the S&P 500 and 23 on the DJIA) might burst at the same time as the housing bubble.


Our optimistic, practical side says that the weaker dollar is indeed the first and most important single step to rebalancing and reviving the world economy. There has just been a pick up in US manufacturing, centred on non-durables, and not yet encompassing exports. This suggests to us that dollar weakening is already helping where it can act quickest: in fast-moving consumer goods, where import substitution is now taking place. The phenomenon will spread to consumer durables, then exports and, eventually, to capital equipment. It is just a matter of time.


There can be no doubt of Greenspan being an extremely crafty fellow. He plays the Administration's game of talking up confidence, but always qualifies his optimism with warnings about longer-term dangers and downside risks. He is insuring his future historical reputation against accusations of irresponsibility. Yet there is a practical benefit to this Greenspan double talk, especially on the topic of deflation. As we (and others) have said many times, the next step in the struggle to maintain the resemblance of economic recovery, once lowering short-term rates has no further to go, is to focus on lowering long-term rates. One way to do this is to have the Fed buy long maturities, while the Treasury issues medium term. This consideration led us to recommend lengthening in dollars. Now that the stock market is going through a rally, Greenspan can and does speak more about deflation, thus encouraging money into long bonds despite the current "attractiveness" of stock markets. In this way, he is talking the private sector into reinforcing the government sector's attempts to keep long-term rates low.


The other major Greenspan double talk is about the deficit. A man of his intelligence and background must recognise that deficits have to be financed. That role was fulfilled by foreign capital flows, but now has to be fulfilled by private sector or Government saving. The spendthrift ways of the Administration will certainly not change till the Presidential Election is over (and maybe not then). Within the private sector, households are still far from saving. Thus it is the business sector which has to save by slowing borrowing and investing less. If just one reason for the "jobless recovery" with no increase in revenues is to be found, it is here: the corporate sector is still being squeezed by household debt and the federal deficit. A weak dollar is the only way out of the impasse, and Greenspan knows it!


America's propensity to "eat, drink and be merry, for tomorrow we die" at a macro-level finds expression at the micro-level in the car industry. Daimler Chrysler, Ford and GM maintained car sales with free financing, damaging themselves in the medium term. Pay back time is upon them and their bond spreads.


Outside the auto sector, corporate bond spreads have come in a long way, while government bonds are now historically cheap. The Daimler Chrysler bond withdrawal of a new issue and the Alcatel significant improvement of terms of a convertible may be signs of investors noticing the mismatch of risk to reward in the corporate sector.


The ECB meets tomorrow amid near certainty of a half point cut.


Recommended average maturity for bonds in each currency


Stay long in dollars and euros, yields have to decline, except where the US Treasury issues (2-7 years).

As of 07.05.03

Dr. Roy Damary

Currencies (by GNI)
No change in view: any recoveries of the US unit may be put down to profit taking on short USD positions. All eyes are on tomorrow's ECB meeting, where the majority of market players are now looking for a cut by 0.50 Any corrective move in the euro is best used in a "buy on the dips" strategy, as the uptrend remains clearly in place. The interest rate differential play continues, with Norway and Turkey cutting their rates again. Mr. Greenspan also left the door open for additional easing, most probably at the next FOMC meeting on 25th June.

EUR/USD: Same comment: each week, the bottom of the Euro is gradually moving higher with 1.1550/80 now acting as a major support, followed by 1.1650. Upside resistance is at 1.1780, 1.1820, 1.1880 and 1.1950


USD/CHF: The major resistance at 1.3070 on the upside has been broken, with 1.3180 and 1.3280 as the next resistances. Downside looks well supported at around 1.2950, 1.2880 and 1.2820.


USD/JPY: Once again, the BoJ seems to have won the battle in defending the USD/JPY 115.00 zone. 117.50/80 is still acting as a major support zone, while 118.90/119.10 is looking a bit heavy at present. Only a clear break above 120.30 would trigger an additional move, direction 121.50


EUR/JPY: Key support has moved up from 135.50 to 137.70. Topside resistance is at 139.30 and 139.80, followed by 140.50


GBP/USD: No change: the key support is holding at 1.6000 and has even moved higher to 1.6280. As long as the rate stays above 1.6280, the next levels are 1.6450, 1.6480 and 1.6550


USD/CAD: 1.4030 remains the key resistance on the upside. Profit taking on long CAD positions has given us the opportunity to re-establish a long CAD position again at 1.3905. We have lowered our stop loss from 1.4050 to 1.3800. The next levels on the downside are at 1.3480 and 1.3430


AUD/USD: The support has gradually moved higher from 0.6350 up to 0.6480. Topside resistance is at 0.6680, 0.6750 and 0.6830. The 'high yielders' remain the market's favourites.



Current spot level


Current spot level

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