Bond Outlook
[by bridport & cie, March 6 th 2002]
A disturbingly strong case can be made this week that the world is
in dire straits: |
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- The war in
Afghanistan has returned with a vengeance
- The mutual killings
in Israel and Occupied Palestine are escalating
- The Bush
Administration has imposed steel tariffs and EU retaliation is very
likely
- In Japan profits
and capital spending are plunging
- Petroleum prices
are rising, and so are the prices of many other commodities.
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Little of this seems to matter, however, in a week which has seen
major rallies in US stock markets and Tokyo. Such paradoxes are a timely
reminder that markets have a mind of their own. |
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The basic thesis we expressed last week was that US, and therefore
world, recovery will be slow and non-inflationary. The consequence is that
all returns on investment will be rather mediocre for some time to come.
Our thesis does not change because of a return of exuberance to the stock
markets. All the same, there is distinct change in "feel" of the market
this week, compared with last. The positive performance of stocks has
washed over into the fixed income markets, with price falls in many bonds,
and spread narrowing among corporates and emerging markets. In other
words, there has been a significant swing from risk aversion to risk
acceptance. |
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Whether the shift in emphasis is justified is debateable (we do not
think it is, but, as we said above, markets have a mind of their own), and
time will tell whether it has staying power. The basic problem is not
necessarily to be found in the damaging events listed in our opening
lines, but in the incontrovertible fact that the American authorities have
not allowed the US imbalances to adjust. One of the implications is that
the economy is ticking along, and consumer spending staying high, because
debt is now so much cheaper to carry. The best that can be said is that
the Fed and Administration have pulled of a "jury-rig" repair, allowing
them to sail on, but at a much reduced pace. Put on the burst of speed,
and interest will have to rise, knocking the wind straight out of the
sails. These considerations reinforce our "sea change" perspective of last
week, when we foresaw a long period of modest growth and
returns. |
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One nice effect of the mood change is that much of the overselling
of Swiss stocks and bonds seems to have ended. There has been a nice
recovery for that engineering company! |
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The US steel tariffs are a measure of appalling economic
illiteracy. Despite the admirable flexibility of the US economy, for which
Europe can learn so much, its steel industry is about as reformed and
modernised as, for example, Japanese banks. Traditional, bulk steel mills
can survive in the face of "mini-mill" competition, only by mergers and
rationalisation. The message has been slow to get through in Europe, but
it has been put into effect. In the USA, the message is simply rejected
and protectionism, the worst possible, "solution" adopted. The USA can now
look forward to an indefinitely inefficient steel industry and prices
higher than those of the rest of the world. Japanese, Korean and European
car manufacturers must be rubbing their hands with glee as their American
counterparts have to deal with a high price of the most important raw
material. Higher steel prices in the USA will do nothing to help industry
to recover, and American manufactured exports to become competitive.
Increased industrial costs will either wash through as inflation (hello,
increased interest rate!), or further decrease profitability (which is
more likely over the short term in view of underused manufacturing
capacity). |
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If we remain sceptical about the US recovery and the recent stock
price rally, words, or at least polite words, fail us for Japan. The best
the WSJ can come up with to explain the Nikkei rally is that inventories
are very low and that a USA recovery will drag Japan with it. Nothing,
precisely nothing has been done to put the economy right: banks have piles
of bad loans and a huge increase in monetary supply has not reversed
inflation. The bankruptcy of Sata Kogyo, a construction firm with nearly $
5 billion in debt, goes scarcely noticed. The wisdom of the new rule to
forbid short selling at less than the last price traded may or may not be
a good idea in its own right (it corresponds to US practice), but its
hurried introduction now is proving a clever way to inflate stock prices
for the March 31 book closing. Thereafter? |
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Recommended average maturity for bonds in each
currency We glad to have resisted the temptation to recommend
lengthening. There is nowhere to move at present from the 3-year averages
we recommend. |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
05.12.01 |
2006 |
2006 |
2006 |
2006 |
As of
30.01.02 |
2005 |
2005 |
2005 |
2005 |
|
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The decision by the Bush administration to impose tariffs on steel
imports to protect its own steel industry clearly shows that the US does
not care about WTO rules. There must be more political thinking behind
rather this than economic analysis of such key implications as the
perverse effect higher steel prices will have on the automotive industry.
Even with these protectionist measures, it might be difficult to save an
already very ill, on the brink of bankruptcy, US steel industry.
|
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Better than expected US numbers (ISM manufacturing and non
manufacturing -former NAPM) helped the equity markets to stage a very nice
rally and showing that more and more investors believe that recovery is
under way. In Japan the punishment of four banks for not having respected
the short selling rules, restrictions for short selling and government
support for the stock market, have helped the Nikkei to establish itself
well above the 10,000, level. It is very important to hold this level
ahead of book closing end of March. Consolidation in a sideway market is
now underway. |
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EUR/USD: Consolidation in a 0.8550 to
0.8750 range for the time being. Only a clear break of 0.8830 would change
our still negative outlook and speak for a recovery up to 0.9030. We are
carefully watching the extremely important support zone of around 0.8500.
A weekly close below 0.8480 would be catastrophic and provoke the next
down move, direction 0.8350. |
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USD/CHF: As long as the exchange
rate stays above 1.6750/80, the dollar remains clearly in an up trend,
with a key resistance level of 1.7250. Only a weekly close below 1.6750
would put the bullish outlook into doubt and suggest for a deeper
correction, down to 1.6550 first. |
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USD/JPY: The yen remains in its range
of 131.50 to 135.30 for the time being. We still favour a continual
weakening of the yen, with our first target of 136.90 followed by 141.00 .
A weekly close below 131.50 would speak for a move down, first to
130.00. |
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EUR/JPY: We keep half of our long
EUR/JPY position at 114.30. S/L 112.80. Consolidation in 114 to 118
trading range may be expected. |
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USD/CAD: We are keeping our short
position USD/CAD at 1.5955 with a S/L at 1.6300. The price objective is
still around 1.5650. |
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AUD/USD: Higher commodity prices are
giving some support to the Aussie. Major support is at 0.5050. A weekly
close above 0.5280 to 0.5330 would open the door for a higher Aussie, with
next objective of 0.5450. |
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GBP/CHF: Extreme volatility at the
moment with no clear trend. It remains in its wide range of 2.3850 to
2.4450. This range will remain unless the USD starts to trend
lower. |
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|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.7250 |
0.8830 |
1.4880 |
135.30 |
115.80 |
Current spot
level |
1.6950 |
0.8720 |
1.4770 |
131.80 |
114.80 |
Support/Breakout |
1.6830 |
0.8480 |
1.4680 |
131.50 |
114.00 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5280 |
0.4310 |
1.6150 |
1.4280 |
307.50 |
Current spot
level |
0.5200 |
0.4255 |
1.5865 |
1.4215 |
294.00 |
Support/Breakout |
0.5050 |
0.4050 |
1.5780 |
1.4050 |
290.00 |
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