It looks like a case of "joke over", so far as the moderate optimism of August was concerned. Scarcely a share market in the world is not now bearish. There will be more bear-market rallies, especially if our hypothetical U.S. Task Force intervenes or that there is relief that September 11th has come and gone without a new act of terrorism. The fundamentals, however, are all moving in the direction we foresaw long ago, and are unlikely to reverse before their rebalancing effect is really felt. The continued weakening of the dollar is an important component of the rebalancing. So are lower stock values.

As our regular readers are well aware, we hold the US Administration in low esteem because of its reluctance to admit that bubbles, once burst, require years to recover from, and that encouraging consumer spending to compensate low industrial investments is only a palliative. A loose monetary policy means, of course, that there is plenty of money around looking for (half-decent) returns. For many Americans (and Britons) the most attractive investment has been housing, but, just as for share prices, house values cannot continue to outstrip nominal GDP growth indefinitely. If, or rather when, prices begin to fall, there will be nowhere left for the consumer to place his confidence and his funds. At that point the weak recovery will become a double dip. Our hope has been that positive GDP growth could be maintained while rebalancing took place. However, the very fact of the U.S. authorities denying the need to rebalance, thereby prolonging the agony, is beginning to make us lose even that modest hope. The other factor that has changed since we cast our lot with the camp for "slow but steady growth" is the huge reversal of the US Government's budget. When money is taken out of the economy for non-productive use, what have you done? Copied that wonderful example of wise micro-economic management, Japan!

Over the last week, spreads have come in for almost all types of bond. This does not imply a renewed confidence in corporate and emerging market bonds. Rather, it reflects even lower confidence in equity markets than in bond markets, as well as lots of liquidity looking for anything better than the money markets. On the supply side, there are few new issues. What does come along is easily sold, but corporations are not too interested in borrowing for lack of investment opportunities. Cleaning up balance sheets has greater priority, and that requires time.

The shortage of new issues also supports the idea that interest rates are to go down further. That is indeed our expectation, as the world flirts with deflation. The opposite danger, stagflation, is weak, but not entirely absent, mainly because of the risk to oil supplies as the Iraq saga unfolds. Nevertheless, the balance of risks still makes us recommend long average maturities. We include Europe among those exposed to the risk of Japanese-style deflation. Even if the switch to the euro has caused a blip in inflation, the fundamentals of unused production capacity and weak labour power are the same on both sides of the Atlantic. It is just that Europe has less of an economic imbalance to put right, so should be reparable more quickly, if only it were not for the problems of reforms in taxes, social charges and labour flexibility.

The Canadian dollar and bonds are receiving attention this week. The Bank of Canada has not lifted rates, which could have strengthened the weak currency, but done no good to bond values or to a very weak and US-dependent economy. We can give no positive recommendation on Canadian bonds.

The bond market in South America now resembles a casino more than a financial market. The key actor remains Brazil. Our argument offered here a few weeks ago is intact: with existing debt trading at 20% yields, how do you refinance in the capital markets? The IMF has provided sufficient funds to get Brazil through the election. Our advice? Pray for a Serra victory and then get out!

Meanwhile, the dangers to the world economy include another ratchet in the USA versus the Rest of the World trade war, as the WTO confirms the illegality of the tax breaks for major US exporting firms called the "Foreign Sales Corporation". The penalty tariffs authorised for the European Union are, at $100 million, huge, giving a measure of how out of step the USA is. The (false) hope is that the mere threat of the punitive tariffs will persuade the USA to repeal the FSC. What a tragedy that the Administration has become oblivious to world opinion in every possible field: trade, military action, international criminal law and the environment.

Recommended average maturity for bonds in each currency
Remain long across the board, except in Sterling.

The first week after the summer recess has started with a huge sell-off in equity markets, reflecting the lower than expected US economic numbers and dragging the US dollar down. As before, the major reason for the dollar remaining under pressure is the shortfall of capital flows towards the USA to compensate for the trade gap. The economic outlook in Europe does not look much better, with growth forecasts revised down again and again. It has to be seen if the EU is forced to loosen the Maastricht criteria at some stage, as the majority of the member countries are no longer within the limit targets and can offer no more hope than to have things sorted out by the end of 2003.

Oil is coming off its highs as a possible diplomatic solution may be in the pipeline, rather than an imminent military attack

EUR/USD: The euro has successfully broken out of the recent trading range and stopped just short of parity. A weekly close above parity is needed to test 1.0030, 1.0080 and 1.0150. Support is coming in at 0.9910, 0.9880 and 0.9830.

USD/CHF: : The strong support at 1.4850 yielded and levels around 1.4700 have been tested. Next support is at 1.4650, 14580 and 1.4500. Resistance is at 1.4780, 1.4850 and 1.4930.

USD/JPY: Same comment: we still believe that any excessive JPY strength should be used to build up a long USD/JPY position. The 116.50-117.00 area should prove to be well supported, and topside resistances are at 118.80, 119.30 and 120.10.

EUR/JPY: Same comment: supports are 115.50 and 114.80. Major and topside resistances are at 116.80 and 117.50, with a buy-on-dips strategy of EUR/JPY.

USD/CAD: 1.5480 remains the key support, if it is broken the rate should go to 1.5350. Topside resistance is at 1.5580, 1.5650, 1.5730, with a strategy to sell USD and buy CAD in the 1.5850 to 1.6000 area again

AUD/USD: It looks like that the Aussie has a lot of difficulty sustaining levels above 0.5500 for long. Resistance remains at 0.5480 and, if broken, the target is 0.5560. Downside support is at 0.5430 and 0.5350.