Bond Outlook
[by bridport & cie, December 4 th 2002]
The economy, on both sides of the Atlantic, is going nowhere fast,
playing out the scenario we painted early in 2000, that the imbalances of
the US economy condemned the world to a decade of sluggish growth, and
that any recovery based purely on interest rate cuts had very limited
potential. In our scenario of low growth/low returns for many years, we
included returns on the stock market. The indices have indeed fallen since
early 2000, but have delivered a powerful rally in recent weeks, in which
"technical" analysts have proven their foresight, while we
"fundamentalists" are left muttering that we do not understand why
investors should find stocks attractively priced at such high PEs and low
underlying growth. As it happens, this week some of the stock market
"bulls" are expressing doubts about the rally's staying power, while some
of the bearish economists are expressing relief that the feared
"double-dip" looks like being avoided. Then a major investment bank came
out with a recommendation to reduce the equity share in portfolios in
favour of bonds. So the short-term bullish excitement may well be
reverting to the primary, bearish trend. |
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The ECB is assumed to be about to cut rates. 25 bps is priced into
the markets, but we expect they will finally take the bull by the horns
and cut by 50 bps. Two opposing views are current about the forex and
economic implications of the cut. The one is that the reduction in the
differential with US rates would lead to disenchantment with the euro,
while the other is that the implied economic strengthening of the euro
zone would lead to a stronger euro. We lean towards the second view for
quite specific reasons. The European economy is far less imbalanced than
the American. Economic data on the euro zone suggest declining consumer
spending, but reasonably industrial activity -- just the opposite of the
USA. Interest rates in Europe are still fairly high, and the current
account balance is positive. Euro zone unemployment is high. These facts
imply that a cut in interest rates can impact consumer spending
positively, and wash through the economy without bumping into the
constraints of imports and inflation taking off. Therefore, despite all
our doubts about a single currency and interest rate, and all our
criticism of labour markets in the major euro zone countries along with
protectionism in France, we see lower interest rates in the euro zone as
more likely to help the economy than cuts in the USA. |
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The sluggish growth everywhere is reflected in the Swiss economy
where growth in GDP was as low as 0.9% in 2001, and is certain to be
close, or even below, zero growth this year. Over the years the Swiss
Franc continues to strengthen, despite every attempt to weaken it via low
interest rates. (This is another example to show that relative interest
rates are an insufficient basis for accessing movements in exchange rates,
although the reasoning for Switzerland - mainly safe haven flows --is
quite different from that for the euro zone.) |
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The scrap over banking secrecy between the EU and Switzerland is
reaching a climax (or a stalemate). The one is demanding an end to banking
secrecy, the other offering to apply its 35% withholding tax to all
dividend and coupon income for EU citizens investing via Switzerland, and
handing over most of it to Brussels. Our expectation is that agreement
will not be reached by the deadline of end December, but what if it is, or
if the dossier is reopened next year? If agreement there is, it will be on
withholding tax, not on lifting banking secrecy, except for criminal
activity. Banking secrecy and the realistic acceptance by the Swiss
authorities that even the country's own citizens have undeclared assets
are too deep-rooted in Switzerland for the Swiss to accept lifting them
under outside pressure. Moreover, all professionals and informed members
of the public realise that banking secrecy is a key attraction for foreign
clients of the banks and the financial advisers. |
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Given that it is primarily the discretion, efficiency and safety of
Switzerland that foreigners seek, rather than returns, the imposition of a
35% tax on dividends and interest receipts (but not on capital gains) is,
in our opinion, of little import. That is a very different situation from
that of the UK, which so ferociously opposed a withholding tax (in favour
of information exchange) lest the Eurobond market, centred on London,
migrate to offshore zones (such as Switzerland?). The arguments against
Swiss banking secrecy take a strong moralistic tone and carry a certain
initial weight, until it is recognised that every country in the EU, plus,
of course, the USA, is perfectly happy to welcome the funds of
non-residents and is not the least concerned about hidden assets and
unpaid taxes. |
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Our conclusion: that there is neither point nor possibility of
action to avoid the extension of the putative 35% withholding tax on
Eurobonds in Switzerland. The only tangible impact will be that fiduciary
deposits in CHF will disappear for EU citizens, who, if they want CHF,
might as well put their money directly on deposit. For the rest of the
world's citizens, nothing will change. |
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Recommended average maturity for bonds in each
currency. No move from an average of five years is yet in
sight. |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
06.11.02 |
2007
|
2007 |
2007 |
2007 |
|
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Markets are entering a typical pre-Christmas market mode, with thin
market conditions and large orders having a visible impact. This has
resulted in the recent trading ranges of recent weeks broadening by 0.50%.
We recommend flexibility, with reduced size of positions so as to have
enough leeway to defend them. |
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EUR/USD: The tight trading range of
0.9850 to 0.9960 held for quite some time before the EUR reasserted some
strength to break again to the upside, pushed mainly by large purchases of
EUR/JPY. A break at either 1.0050 or 0.9850 would open the door for the
next move of at least 100 to 150 points. |
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USD/CHF: The trading range is
also becoming broader here with 1.45 to 1.50 most likely to pertain. A
clear break on either side would provoke the next move of 150 points.
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USD/JPY: As said, we still believe in
continued medium-term JPY weakness, and our first price objective of
USD/JPY at 125.00 has already been reached over the last couple of days.
The big support zone at around 120.- has moved up to around 122.50. The
next hurdles on the upside are 125.50, 126.30 and 127.50. |
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EUR/JPY: The big support zone of
120.50 seems to have held and moved up to the 122.-area. Upside resistance
is at 125.50, 126.20 and 127.50. Here also we believe in further upside
potential medium term, but expect extreme volatility to
continue. |
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USD/CAD: Keep your long CAD exposure
established in the 1.5900 to 1.6000 zone. Set a stop profit at 1.5650,
with next support coming in at 1.5530 and key at 1.5480. A break of the
latter would set a new price objective of 1.5150. Upside resistance is
1.5670 and 1.5730. |
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AUD/USD: Same comment: consolidation
in 0.5510/30 to 0.5650 range with a buy-on-dips strategy for the Aussie
below 0.5550. A loss of 0.5480 would send the Aussie immediately lower,
with 0.5430 as the first objective. |
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|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.4780 |
1.0060 |
1.4780 |
125.50 |
125.50 |
Current spot
level |
1.4695 |
1.0015 |
1.4715 |
124.70 |
124.85 |
Support/Breakout |
1.4650 |
0.9940 |
1.4690 |
123.10 |
123.80 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5630 |
0.5050 |
1.5670 |
1.5780 |
328.00 |
Current spot
level |
0.5610 |
0.5015 |
1.5580 |
1.5730 |
323.00 |
Support/Breakout |
0.5480 |
0.4910 |
1.5480 |
1.5680 |
318.00 |
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