Behind the fog of war lies...an emerging US war economy. There are tiny signs of manufacturing pick up in two areas: the defence and housing. The first is scarcely surprising in view of Bush's spending, but the second is more subtle. When the typical citizen fears that there is nothing out there to protect his wealth, he draws back into his shell, i.e. his home. "If all around me falls apart, and I even lose my job, at least I'll have a home." Many commentators seem to think the housing boom (and there is one in the UK and Australia too) is healthy. We think otherwise. In macro terms it means less savings and leveraged investment in static assets rather than productive assets. A housing boom runs counter to economic rebalancing.

The common view of investors is that a war with Iraq will be short and successful, and that the pattern of the 1991 war will be repeated: an equity rally, with a corresponding sell-off in bonds, then a return to reality. Maybe, maybe not. When a market discounts future events it can take prices to fantasy levels, just as US stock prices are still valued at twice their historical basis and twice the basis found in Europe. US pricing reflects a "recovery in six months" plus "the stock market always anticipates recovery within six months". How long before this circular argument is seen for the nonsense it is?

As readers well know, we do not give much credence to either the economic policy of the US Administration, or to "Bushwaconomics", a word which reflects, amongst other things, a nasty surprise awaiting down the road when all is said to be so reassuring. A grim satisfaction came our way in the recent report by a US steel users group. Just as we said, when the steel tariffs were imposed, that sufferers would include US steel users whose costs would increase and competitiveness decline. The report claims that there have been more jobs lost from the protectionism (200,000) than the total number of people employed in the steel industry, a perfect example of Bushwaconomics. The steel industry spokesmen disagree, but they would, of course.

We do not give much credence to the policies of European Governments, either (in fact, it is difficult to find any government deserving of credence today - Switzerland maybe?). Yet, despite all the efforts of, particularly, the French and German Governments, and of the ECB, Europe does have a few things going for it. The Euro zone has a large positive current account balance, a strengthening currency, and room to lower interest rates. Its stock markets are at sensible valuations and many stocks give decent dividends. Buy recommendations for European shares have a distinctly more realistic tone than those for US shares.

The universal assumption among commentators is that the recovery will be and can only be led by the USA. Today we want to lift our head a little further above the parapet and question that assumption. For three years we have been saying that the US economy has overspent, and recovery without rebalancing can only be weak and short-lived. Of course the world still "believes in America", if no longer in its politics, at least in its economics and military power. What we detect is the beginning of a change. One sign is the shifting of government and private reserves towards a mix of dollars and euros, plus, until the fog of war lifts, gold. Another is the growing use of the euro in international trade in the former Soviet Union. Even the Pound Sterling seems more closely attached to the euro than to the dollar.

Now if only the European Governments would get out of the way!

Both from our clients and from the yield curve, it is clear that a large demand has arisen in Europe for long-dated inflation-linked bonds. We can hardly suppose this implies that inflation is round the corner. Rather, it reflects a sense of adding a solid, home grown instrument to protect wealth rather than seek big returns. You do not have to expect inflation to want to buy "linkers"; it is sufficient to recognise that the risk exists, and, of course it does, even if small. A number of institutions are creating inflation linked "hybrids". Our duty is to warn investors that these carry a significant cost and liquidity risk. Better stick to simple and liquid Government issues.

Recommended average maturity for bonds in each currency

We confirm our recommendation to lengthen the euro from five years to ten.

EUR/USD: The correction was quick and short-lived, with levels slightly below 1.0700. Since then, however, a new high of 1.0935 has been reached, though without follow through yet. Some consolidation below 1.1000 is the most probable outcome until a clearer picture on Iraq emerges.

USD/CHF: CHF remains king. So far a low of around 1.3400 has been tested, and a price objective of 1.3250 is indicated. Upside resistance is at 1.3480, 1.3550, 1.3630 and 1.3700. Here as well some consolidation may be expected.

USD/JPY: Knowing that the Japanese are now secretly intervening to weaken the yen, a broad consolidation band of USD/JPY 117.50 to 121.50is most probable. A substantially weaker JPY will depend on who is going to become the next Governor of the BoJ.

EUR/JPY: Extreme volatility continues in this cross. The trend remains upward, and 130.50 has been seen. The next upside resistance is at 131.00 and 131.80. Downside support comes in at 129.80, 129.30 and 128.80

USD/CAD: Same comment: CAD continues its appreciation and was able to test levels slightly above 1.5100 so far. A weekly close below 1.5050 is needed to speak of a medium term trend change with a price objective of 1.4200. Maybe the time is not quite ripe. Upside resistance is at 1.5280, 1.5350 and 1.5410

AUD/USD: Same comment: Key support is now coming at 0.5780. The trend remains clearly oriented to the upside, with 0.5930, 0.5980, 0.6050 as the next price objectives