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.


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.


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.)


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.


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.


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.



Recommended average maturity for bonds in each currency.
No move from an average of five years is yet in sight.

As of 06.11.02

Dr. Roy Damary

Currencies (by GNI)


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.


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.


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.


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.


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.


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.


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.



Current spot level
Current spot level
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