Bond Outlook
[by bridport & cie, August 7th 2002]
Just a few weeks ago we were arguing that general expectations of a
rise in interest rates were premature, but supposed that the next move
would be upward, probably led by the UK because of the fears about a
housing price bubble in that country. Now, it seems that we were too
optimistic in supposing that the poor economic fundamentals would merely
slow rate hikes. This week the talk is about lowering rates, with the US
showing the way, the UK following and the ECB bringing up the rear. It is
even alleged that stock markets rallies in this bear market reflect a
growing belief in a rate cut. However, we prefer to understand the extreme
volatility of the markets as a reflection of share prices being in
"no-man's land" - neither "new economy" nor "old economy"
valuations. |
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We incline to the expectation that the FED will loosen further,
although whether it will do any good is a different matter. Stocks will
probably rally until it is realised that the reason for the cut is the
poor fundamentals. Long-term readers will remember our " not by interest
rates alone" comment made two years ago on how to bring about a lasting US
economic recovery. It still applies. Private, public and national debt
must be rebalanced. The USA is living beyond its means, huge though they
may be. |
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Deflation is the great danger facing the US economy, and, by
extension, the world's. When an economy is only spluttering along with
short-term rates at only 1.75%, it is already a sign of poor fundamentals.
A further cut will but show the situation to be worse, even Japan-like.
No, it will not be quite that bad, because the USA does not have the same
problem of a non-spending elderly population. It does, however, have a
baby boom generation coming up to retirement, and feeling extremely
unhappy and unsure about their pensions as so many 401K's (private
pensions with the option of large equity exposure) lose value inexorably.
The resilience of American consumers (some might say irresponsibility,
but, after all, they are only doing what the Administration asks), in
spending despite a poor economy is remarkable, but even they cannot resist
indefinitely. Spending must turn into saving - good in the long run, bad
in the short. |
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The USA also needs time for rebalancing. Companies and, well behind
them, households are working their way out of debt - a good thing, but it
requires time. The lower dollar will help bring international trade nearer
balance, but it takes time. Even stock market valuations will return to
historical bases - but it takes time (may we remind readers of our
observation last week that SP 500 average PEs are still higher than when
share prices were at their peak). The sad thing is that the Administration
cannot face the need for time; it wants and encourages the American people
to believe in instant cures. Such speedy recovery is just not possible
after the excesses of recent years, epitomised by the accounting scandals.
For this reason, tighter rules on financial reporting, necessary though
they be, will not bring the bear market to an end. A more subtle change in
boardrooms will be part of the return to health: a return to the basics of
making profits from satisfying customers. Less hype and more real bottom
line. Less acquisitions and more organic growth. For those of us with long
memories, more of the style of the late Lord Weinstock and Harold Geneen.
We would also propose that time is needed by the rest of the world to
become less dependent on US deficit-based demand for
goods. |
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In addition to the need for time to repair the self-inflicted
damage to the US economy, there is another powerful argument in favour of
our view that this whole decade will be one of modest growth and returns.
The entire debt structure of the USA would come tumbling down if ever the
economy recovered so quickly that interest rates had to be raised to
dampen inflation. If the USA climbed too quickly out of this hole, it
would fall straight back in again. A slow clamber out is definitely
indicated! Europe should be seizing the opportunity to show economic
leadership. However, the timing of the French move to the right (just
before the summer break) and of the German election means that not much
progress may be expected until later in the year. |
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Our fears about Brazil are not exactly put at rest by Paul O'Neill
allegedly making up for his gaffe. When a country has a friend like him,
it needs no enemies! |
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No change in our recommendations of maturities is needed, although
we have clients moving in both directions: to cash in case equities turn
round, and to 30-year maturities in case they do not! |
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Recommended average maturity for bonds in each
currency Stay long across the board, except in
Sterling. |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
10.07.02 |
2012 |
2007 |
2012 |
2012 |
|
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The UD dollar held up very well last week, despite the three
consecutive falls of the US stock markets on Thursday, Friday, and Monday.
Yesterday, the good performance of the stock markets helped the USD to go
a little further up. We observed yesterday an inverse movement from last
week's: investors were selling European bonds and buying back their short
positions in US shares. If this scenario could continue, the major USD
repatriation should more than support the dollar. The situation in Latin
America remains fragile. Brazil seems confident on the negotiations with
the IMF and the USD/BRL came back a little after the sharp move of last
week. |
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EUR/USD: Contrary to our expectations,
the euro slid below 0.9750 and went through 0.9675. At the current level,
we suggest to keeping a close eye on the market. A daily close below
0.9620 should announce at least 0.9525. In the other direction, a quick
come back above 0.9750 is needed to target 0.9900 and return to last
week's bullish scenario. |
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USD/CHF: Our favoured scenario
was not correct, but, at least, as announced, the break of 1.4950 pushed
the greenback directly to 1.5100 (1.5140 at the top). If the movement
continues, a break of 1.5150 should open 1.5300. A rapid return below
1.4950 would mean it was a false break. |
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USD/JPY: The exchange rate is flirting
with its resistance at 120.80 (see last week's comment). A daily close
above 121.00 should allow the dollar to reach 122.75. |
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EUR/JPY: Key support is at 116.40. A
clear break there should provoke a movement of at least a 100
pips. |
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USD/CAD: We clearly missed our target and have
been stopped at 1.5900 (50 pips profit). Support is at 1.5800 and
resistance 1.6050. |
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AUD/USD: A clear break of 0.5350 is
needed to be bullish and re-target 0.5500. Support is at
0.5250. |
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USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.5150 |
0.9750 |
1.4625 |
121.00 |
117.60 |
Current spot
level |
1.5065 |
0.9675 |
1.4575 |
120.80 |
116.90 |
Support/Breakout |
1.4950 |
0.9600 |
1.4460 |
119.40 |
116.40 |
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AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5350 |
0.4600 |
1.6050 |
1.5450 |
310.00 |
Current spot
level |
0.5310 |
0.4505 |
1.5860 |
1.5360 |
308.55 |
Support/Breakout |
0.5250 |
0.4450 |
1.5800 |
1.5250 |
300.00 |
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