Bond
Outlook [by bridport
& cie, May 7th 2003]
Just last week we were struggling with the question of whether
there would be inflation in the USA or not, leaning towards a "no" answer,
but still hesitating. Now that the Fed has reached the same view, we are
confident that the anti-inflation forces of spare capacity, rising
unemployment, foreign competition and falling commodity prices will
overcome the inflationary forces of a falling dollar. The Fed has returned
to an easing bias, implying a possible cut in the overnight rate. This,
however, may be too difficult to achieve in view of the Treasury's policy
of borrowing at 2, 5 and 7 years, in the hope of keeping down the yield at
the long end of the curve, or taking it lower. The Treasury policy to deal
with the budget deficit, leading to excess medium-term supply, suggests
that five years is not the place to be. What average maturity should
therefore be recommended? "Very short", the view of many of our clients,
is one possible answer, to avoid the loss of value as 2-7 year yields
rise, but, of course, returns are very low. |
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The alternative is, however, to go as long as possible on the basis
that the US economy is seriously damaged, inflation subdued and the
Treasury policy will indeed raise the yield curve only over the 2-7 year
range. The common wisdom in the USA is that only lower long-term
rates will encourage corporations to invest, so the Fed, presumably under
the Administration's influence, wants to generate an expectation of
low inflation. This is a dangerous and difficult game, juggling the
inherent contradictions of loosening money supply, cheapening long-term
debt and financing a huge and growing deficit, all in the context of a
weakening dollar. There is the additional danger of lowering inflation
expectations so much that the economy falls into deflation. All these
reasons are now making us move our "5 years, watchlisted 10" for the USD
to a formal recommendation of ten years, matching the recommendation for
the euro. |
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Financial markets are going through an unusual period. While
fundamental data are universally negative on both sides of the Atlantic,
stock markets have gone up, more so in Europe than in the USA, and spreads
both on corporate bonds and on emerging markets have come sharply in. Our
view is that the flight to quality before the Iraq War is now being
reversed, especially in European share prices, which are coming back from
greater declines than in the USA. There could even be some positive
reasoning in that both the French and German Governments are talking
reform of social benefits (and costs), and an ECB rate cut has to happen
soon. Justified or not, risk appetite is rising, even as the economy is
declining. Have corporate bond spreads further to come in, especially at
the lower end of the investment grade, which has performed best in recent
months? We incline to a "yes" answer so long as the equity rally
continues, but that could peter out any day as reality triumphs over hope.
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Where we do find reasons for optimism is the fall of the dollar
leading to an export-led recovery in the USA (that does not contradict our
above analysis - it takes a couple of years for the effect to work
through), and to putting more pressure on irresolute governments in Europe
to reform. |
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We are beginning to see the long-foreseen weakness of the dollar as
"fin d'époque" (that means "end of an era", but it sounds better and has
historical connotations!). For about seventy years the standard expression
to describe the foreign exchange holdings of nations has been "gold and
dollar reserves". With gold taking a smaller place in reserves and the
euro a greater role, we will soon be referring to "dollar and euro
reserves". International trade has largely been conducted in dollars. That
role is now being shared more and more with the euro. The lesser role of
the dollar will however be but a symptom of the most fundamental change of
all, viz. that the USA steps out on the long path towards living within
its means. |
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Not that George W. and friends see any of this in their worldview.
"Living beyond their means" is a way of life for them. Let the Federal
deficit blossom; let the Social Security gap explode; encourage households
to increase their indebtedness! Future generations can pay for this
generation's profligacy. Well, George W., not all your compatriots go
along with that approach, and the rest of the world certainly does not.
Yet in the end what matters is what economic forces do, and they
have already started to act. |
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The Administration proposes lowering corporate tax on repatriated
corporate profits for a limited period. It smacks of desperate measures to
us. |
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Recommended average maturity for bonds in each currency
|
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To our recommendation for maturities in euros to average ten years,
we add the dollar. |
Currency: |
USD
|
GBP
|
EUR
|
CHF
|
As of
22.01.03 |
2013
|
2008
|
2013
|
2008
|
|
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Thin market conditions, coupled with many stop-losses, with foreign
central banks (South East Asia, Eastern Europe and MEA) still diversifying
their reserves and with technical model funds jumping on the bandwagon,
have helped to push the euro over a very short period in the direction of
USD 1.1500. Yesterday, the FOMC left rates unchanged with a still
uncertain outlook and concern about the low level of inflation. With US
interest rates at nearly all time lows, and no change being expected in
the foreseeable future, as well as huge tax cuts being pushed through, it
looks like that the only way to trim the twin deficits is a still weaker
USD. All eyes are on the ECB to see whether the long awaited rate cut is
going to be announced tomorrow, or if it has to wait till June.
|
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EUR/USD: The trend remains clearly
oriented to the upside with 1.1630/50 being projected as the next target.
We still rather expect a short-term correction, with 1.1380 as the first
support, followed by 1.1310. Only a clear break below the latter level
would bring about a deeper correction direction to the 1.1010/50 area. A
lot will depend on the ECB and by how much the expected rate cut is going
to be. |
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USD/CHF: Not only was the critical
support zone at 1.3480 been broken, but the recent outstanding low at
1.3230 has also been tested. The next support is around 1.3130/50, with
1.2800 as the next big level on the downside. The short-term technical
resistance level is at 1.3380, with a clear break opening the door for the
1.3650/1.3750 zone. |
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USD/JPY: Despite verbal intervention and
new measures being looked for by tomorrow, the USD/JPY broke the first big
support at 117.80 in sympathy with the other currency pairs. The next
support is at 116.50, 115.80 and 115.10. As Japan is like the USA in
seeking a weaker currency, it has to be seen if the BoJ is showing its
teeth in intervening close to 115.00. A weekly close below 114.80 would be
catastrophic, and send the USD/JPY much lower, in the direction of 110.--
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EUR/JPY: 133.50 is acting as the major
support now, with our objective of 134.50 nearly reached. The next
resistance is at 135.00, 135.50 and 136.50. A weekly close below 133.50
would send this cross immediately down, direction 131.50 |
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GBP/USD: The support level has moved up
from key 1.5850 to 1.6000. So long as the rate stays above this, the next
levels are 1.6150, 1.6230 and 1.6350. |
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USD/CAD: The high yielders remain the
market's favourites. With the BoC still leaving the door open for further
interest rate hikes, the 1.4350 support area broke to reach a low around
1.3830. The next big levels are 1.3780, 1.3650 and 1.3550. Upside
resistance is at 1.4030 and if broken, 1.4350 would be the key resistance
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AUD/USD: Our target of 0.6350 has been
reached and acting as a major support now. 0.6445 has already been seen,
with 0.6480 and 0.6550 the next targets |
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|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.3380
|
1.1480
|
1.5180
|
117.80
|
134.50
|
Current
spot level |
1.3290
|
1.1400
|
1.5150
|
117.30
|
133.70
|
Support/Breakout |
1.3150
|
1.1310
|
1.5050
|
116.50
|
133.30
|
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.6450
|
0.5780
|
1.4030
|
1.6130
|
348.00
|
Current
spot level |
0.6400
|
0.5710
|
1.3940
|
1.6055
|
343.50
|
Support/Breakout |
0.6330
|
0.5650
|
1.3780
|
1.5980
|
335.00
|
|
|