Bond Outlook [by bridport & cie, January 8th 2003]

You do not have to be a Democrat to see the new Bush package as a short-term fix to a long-term problem. Cynics like us might even say that the only explanation is that the Cowboy so much wants to be re-elected that he is prepared to throw money at the economy to keep consumers (and voters) happy till the Presidential Election. Obviously the new Economic Adviser, Stephen Friedman, has yet to exert much influence in the direction of balanced budgets!


Freeing dividends of tax to investors is quite the wrong way to eliminate the double taxation of dividends. A bias in favour of corporate debt over equity has been present for as long as anyone can remember because interest payments are tax deductible for companies, but dividends not. A great opportunity to correct that distortion is being missed. If the Bush plan goes through unaltered, dividends will be taxed at corporate level and interest at investor level - totally irrational!


Just a year ago most commentators expected a recovery in six months' time. We were more pessimistic in foreseeing a recovery only after a year. Yet we were too optimistic. This time round, commentators are again writing of a recovery in six months. They have been a permanently rolling six months since the end of the bubble and we expect them to keep on rolling! Nevertheless, we do see positive signs towards a long-term rebalancing of the US economy in the lower dollar and the gradual debt reduction of corporate America. The negative forces on the American economy are the continued encouragement by the Administration of consumer spending in preference to corporate investment, plus an ever-increasing internal deficit, which is bound to compete with corporations for funds.


No one, not even the most powerful economy in the world, can continue indefinitely spending more than they earn. The USA has been allowed to get away with this because the rest of the world is so happy to hold dollars and to buy American securities. A parallel might be seen with the neighbour who enjoys a much higher standard of living than everyone else on the street, but is really only living on borrowed money. A day of reckoning always comes. When will it be for the USA? Possibly years away, possibly any time. Bush will certainly do all he can to put it off till he has won a second term. He will be fighting market forces and, presumably, his new economic team, who are not yet able to bring in a sense of realism beyond the need for a weaker dollar. The consumer, however, does appear to be spending less and reducing the rate of remortgaging. The sooner he tightens his belt, the better for the economy in the long run, even if it means a one-term Presidency!


As readers will be well aware, corporate bonds spreads have come in strongly since their widest point last October. Arguments are advanced that corporate debt reduction is well underway, that the bad apples have now been eliminated, and that overall credit risk has now declined. Debt reduction may indeed have progressed, and a good thing too, but readers will forgive us for warning them about the many traps for the unwary in corporate bonds. Our sense is that the sheer frustration of investors in losing so much money over three years of equity losses, and in seeing the apparent end of the Government bond rally, is pushing them towards the "search for yield" despite the current situation calling for "protection of assets" as the leitmotiv for portfolio management - as it has been since we first wrote in early 2000 of this decade being one of poor returns while past excesses are worked off.


As the euro climbs against the dollar by default, the danger of European deflation increases, with Germany dragging the rest of the euro zone into the same pit as Japan. Inaction rules the day in Germany, unless you count as "action" the forthcoming public sector strikes, whose only result will be to push a stagnant economy backwards. Let us hope that German inaction does not rub off onto the ECB, said to have more room for manoeuvre in lowering rates now that the currency is stronger. Unlike in the USA, a little encouragement to European consumers to spend would work wonders.


Sufficient investors expect the weaker dollar to create inflation in the USA for "TIPS" to be proving attractive. Their case is unproven in the light of Asian competition and spare US production capacity. We see inflation returning only when exports pick up and when spare capacity is absorbed.


Recommended average maturity for bonds in each currency


No move yet from an average of five years, but we have rolled forward with the change of year.

As of 8.01.02

Dr. Roy Damary

Currencies (by GNI)
It is perhaps unfortunate, but the market is going to be politically driven over the next couple of weeks. Sentiment remains extremely negative towards the dollar, and a good strategy will be to sell the USD on rallies. The huge stimulus package announced by Bush yesterday did not impress the forex market at all, in the light of the USA needing about USD 2 billion capital inflows per working day to finance its growing external deficit.
It looks likely that an agreement will soon be reached in between OPEC and non-OPEC members to increase drastically their daily output as a countermeasure to the rise in oil prices.

EUR/USD: In thin market conditions our objective of 1.0500 has nearly been reached, and we would only look for further euro strength on a weekly close above that level. Support comes in at 1.0380, 1.0250 and, important, at 1.0180. A close below that last figure would challenge parity.


USD/CHF: Our target of 1.4000 has been reached and even overshot to 1.3850. Only a weekly close below that would speak for further USD weakness in the short term. Upside is 1.4060, 1.4150, 1.4280, 1.4350 and 1.4500.


USD/JPY: Here as well, the break of 120.-- provoked stop/loss selling nearly down to 118.--. We established a long USD/JPY position at 118.90, with a S/L at 117.80. Strong support is at 118.00, upside resistance at 120.60, 121.30, 121.80 and 122.50


EUR/JPY: The euro remains strong against the JPY, but 125.50 currently looks tough to break. Supports are coming in at 124.80, 124.30, 123.50 and 122.50.


USD/CAD: We took profit on our long CAD position at 1.5533 (397 points on a position established at 1.5930). Consolidation above the key support of 1.5480 is expected. Upside resistance is at 1.5650, 1.5730, 1.5780 and 1.5850


AUD/USD: The Aussie finally benefited from strong buying interest by the investment community and was able to break the 0.5650 resistance zone, which is now acting as a strong support. The next levels are 0.5780, 05850 and 0.5910.



1.0480 1.4060
Current spot level


Current spot level
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