As hostilities reach a climax in Iraq, financial markets and commentators are looking again at the fundamentals and not liking what they see. The only bright spot in the US economy would appear to be the wholesale business, while the only countries perceived as having "reasonably good" economies are Canada and the UK. The core countries of euro zone remain unreformed, with even the European Commission pointing out the obvious need. In the meantime, the US Administration is holding to its line that low interest rates and the after-war effect will lead to a recovery, while ratcheting up the twin deficits with military spending and tax cuts. Even Alan Greenspan has been "bought". How else can we explain him not even mentioning the twin deficit problem and only weakly stating that he was not convinced that tax cuts were a great idea? We have to admire the Administration's consistency, while fully expecting their policy to fail. We lament that patriotism and economic policy are now so intertwined and that there is no "loyal opposition" on economic policy, only questions from economists rarely known or heard outside their own circle (a brave exception is Stephen Roach of MS). Amusingly enough (except it is not really funny) J.P. Morgan sing the Administration's song, while Morgan Stanley at least publish Roach's views.

Investors are faced with these two opposite views, epitomised by the two "Morgans":

• If the Administration are right, then recovery after the war will ensue, stock markets will rise, the dollar will strengthen as investors move back into America, and the Fed will raise rates. In this scenario, the dollar is the currency of choice, but with mainly cash holdings now, ready to capture the stock market rise and future higher rates in fixed income.
• If the economists are right, then any post-war upturn will be short lived, the dollar will weaken, interest rates will not be increased and even long-term yields will fall. Inflation will be kept at bay by increasing unemployment and low profitability. The euro will strengthen by default.

We could believe the former but for the USD 500 billion twin deficit, the great "unmentionable" for the Administration. So, as regular readers will know, we are forced towards the second scenario. The difficulty for those of us who take that route is that short-term moves, linked, for example, to Saddam's demise, may make us look wrong. Our view is that, unless investors throw in the towel and go all cash, the scenario below based on quality-bond and five-year maturities (except the euro at ten) remains valid, with no change in maturities despite our questioning last week of our recommendation for dollar-based bonds.

One of our underlying creedal statements is that economic forces eventually have their way. That is why we foresaw the fall of the dollar and expect it to trend downwards. Now the US consumers are doing what we thought they would do two years ago: tightening their belts and saving more. They are "disobeying" the Administration, but actually taking a vital step towards a healthy economic recovery, which will follow once the post-bubble excesses are finally cleared away.

Two observations specifically about bonds this week:

• The search for yield is narrowing spreads in emerging markets. We wish there were countries other than the "usual suspects" (Russia, Turkey, Latin Americans), but we cannot find much liquidity elsewhere.
• The fear of credit risk (with recent examples of downgrading) is widening corporate spreads, just possibly to the point of being oversold (you will not often see us write that, and we still warn that corporate bonds demand strong credit analysis capability).

The Swiss Franc has apparently lost its safe haven status, much to the relief of the SNB and Swiss industry. Clearly there are advantages to independent monetary policies as in Switzerland and the UK, especially now that the euro is stronger than most European authorities would like.

Recommended average maturity for bonds in each currency

We maintain our recommendation for maturities in the euro to an average of ten years.

EUR/USD: 1.0500 remains the big support on the downside. 1.0760 the pivotal point. A weekly close above this would open the door for a further test of 1.0880 and 1.0930. Intermediate support is at 1.0710 and 1.0650

USD/CHF: After breaking the 1.3750 area, a new high of 1.4080 has been reached so far. A weekly close above 1.4100 would speak for further USD strength, but looks unlikely for now. Support is at 1.3780, 1.3710 and 1.3650

USD/JPY: Little change: verbal intervention is supporting the USD/JPY between 117.-- and 118.--. The upside is 119.10, 119.80 and 120.30, followed by 121.00.

EUR/JPY: Little change: broad consolidation in a 125.50 to 129.50 range, coming off the lows and testing the upper side of the range again.

GBP/USD: Little change: key level is at 1.5850, but 1.5500 looks well supported. However, so long as the rate stays below 1.5850, the pound will remain depressed.

USD/CAD: Little change: since key support at 1.5050 was broken, the CAD has remained one of the market's favourites. The next big support is at 1.4650 and 1.4580 . Upside resistance: 1.4850 and 1.4930

AUD/USD: Little change: key level is around 0.5970/0.6000, below which the objective would be 0.5880, while topside, a weekly close above 0.6000 would be needed to generate some renewed buying interest.