Bond Outlook
[by bridport & cie, November 7th 2001]
We thought that last week was to be the beginning of unwinding the
tensions in financial markets, such as high stock valuations in parallel
with a flight to quality in bonds. However, the widespread faith (and we
deliberately choose the word "faith" over "belief") in a strong rebound in
the US economy in the second half 2002 has not yet been dented. In fact,
the nearest thing anyone can offer as good news is that a given decline in
profits is somewhat less than anticipated. Lay-offs continue, consumer
confidence is declining and, above all, corporations are investing little
because they have over-invested. A lowering of interest rates, even to the
negative short-term real rates now in place, cannot make corporations buy
what they do not need. Neither can it make consumers buy durables or take
holidays when they fear job losses. Yes, free automobile financing can
push them to bring forward car purchases, but only with the risk that car
sales will drop drastically once the special deals are over.
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What will make corporations invest again? Only time and rebalancing
of expenditure to debt, an argument we have put forth in this weekly for
many months (avid readers will remember that we called it "not by interest
rates alone"). |
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Will the renewed interest in Keynesian economics (with governments
picking up the slack of reduced private sector spending) achieve what
interest rates alone cannot? The US Government's budget surplus has moved
into deficit, and Europe will follow the US into extra public spending,
even if more slowly. The forecast US deficit ($50-150 billion) is
affordable in a $ 40 trillion economy. It will bring positive results,
just not so quickly as financial markets are wanting to
believe. |
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Deficit financing implies competition for money between the private
sector and the Government. When there is much money available as today,
there is no problem with that. The Government can borrow easily at almost
any maturity, and cheaply, too, taking cash out of the economy but causing
neither inflation nor its sister, higher interest rates. But all that
holds only so long as the private sector is in the doldrums. If an
economic recovery is further away than mid 2002, then the US policy of
rate and tax cutting, and increased Government spending can continue. When
the policy does finally work, however, expect a rapid turnaround in
interest rates. Do more than "expect" - hope and maybe even pray! Because
there is probably only another 0.5% available for further cuts in the Fed
rate, and if "traction" is not eventually achieved, the USA and the world
will be in almost as much trouble as the only other country with very low
interest rates plus a Government deficit: Japan. With this reasoning, we
are tempted to paint a scenario of a return to growth at the end (not the
middle) of 2002. |
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Corporations are taking all they can from the corporate bond
market, but only those corporations with the best credit ratings. For them
the money is cheap, for the investor, the spread over Treasuries
sufficient. Corporations are behaving just like the Government, "we can
sell our bonds for low rates, so let's do it!". What a pity that the
corporate cash thus raised is being used for current cash flow purposes to
compensate poor operating cash flows, rather than to finance new
investments. |
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According to S&P, Argentina is now in "technical default",
which means the proposed restructuring breaks the terms of existing
issues, although as yet no interest or principal payments have been missed
(no foreign currency payments are due anyway before February 2001).
Domestic bondholders have no real choice but to accept, while foreign
lenders will ensure that the word "technical" is shortly replaced by the
word "real". That is partly because a solution involving subjugation to
Argentinean law is perceived as worse than bankruptcy. |
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The extreme dependency of the world economy on the USA is now very
obvious. Europe's decline is following the USA's, with the UK being the
last to be sucked along. We still allow ourselves some moderate optimism
that the smaller imbalances in Europe will let the economies decline by
less than in the USA. We would, however, have to be very optimistic to
suppose that interest rate cuts in Europe can achieve real results before
the USA turns round. |
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Conclusion: settle down for a good year of lack of growth and stay
long on the yield curve as the economic recovery and higher yields are
both a long way off as we currently see it. |
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Recommended average maturity for bonds in each
currency Stay long. |
Currency: |
USD |
GBP |
EUR |
CHF |
Virtually
unchanged since 15.08.01 |
2008 |
2006 |
2011 |
2011 |
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After an additional rate cut by the Fed from 2.50% to 2% for Fed
Funds, the pressure on the ECB to follow suit tomorrow is mounting. Last
week's decision by the US Treasury no longer to issue 30-year bonds came
as a surprise, with the effect that yields have come off since then by
nearly 0.50 %, especially for the longer dated
maturities. |
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EUR/USD: The 0.9000 zone remains the mid
point. After managing to stay above 0.9000, the next target is 0.9150
followed by 0.9240 and 0.9280. The major support zone is 0.8800 to 0.8850.
The short term favours the upside. |
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USD/CHF: Sideways trading is
expected to continue in a broad consolidation band of 1.6100 to 1.6600.
Key resistance and breakout level on the topside is still 1.6500/30. On
the downside, minor support is at 1.6210, followed by 1.6150 and 1.6080,
before the psychological barrier of 1.6000. |
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USD/JPY: In the short term, we continue
to favour range trading in a 120.00 to 123.00 range. Fear of BoJ
intervention puts a solid base below 120.00 , while break out level is
above 123.30. |
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EUR/JPY: A broad consolidation range of
107.- to 112.00 is in place with the BoJ protecting the
downside. |
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USD/CAD: Continued weakness in the US
economy is hurting Canada's exports, and trade disputes on lumber are
putting the CAD under pressure to reach nearly our target of 1.6000. We
would use this excessive weakness to buy some CAD (50%), doing the second
half at 1.6080 with a S/L at 1.6200. |
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AUD/USD: The Aussie has created a solid
base above 0.5000 but now needs a weekly close above 0.5180/30 to progress
further direction 0.5280. |
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GBP/CHF: Extreme volatility will remain
in this cross. The GBP managed to go through resistance at 2.3850, with
the next target at 2.4100. Major support comes in
2.3550. |
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USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.6350 |
0.9080 |
1.4880 |
123.10 |
112.00 |
Current spot
level |
1.6310 |
0.9015 |
1.4700 |
120.95 |
109.00 |
Support/Breakout |
1.6130 |
0.8950 |
1.4650 |
119.80 |
108.80 |
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AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5180 |
0.4280 |
1.5990 |
1.4680 |
283.00 |
Current spot
level |
0.5150 |
0.4210 |
1.5930 |
1.4650 |
281.00 |
Support/Breakout |
0.4980 |
0.4080 |
1.5750 |
1.4480 |
272.50 |
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