While equities are rallying and bond prices falling, it is easy to lose track of the real economy. Our view is that bonds are now range trading, that the equity rally does not have positive fundamentals behind it and that deflation is still crouching at the door. Indeed the US deflator is stuck at 0.7%, simply too low for the deflation risk to be dismissed. Unemployment is still rising and manufacturing going nowhere. It seems like more of what the last three years have given us: continually rising consumer credit feeding retail sales and housing, but washing through to increased imports rather than industrial investment. All sectors in the USA are highly indebted - households, federal government, states and industry - but only industry is doing anything serious about it. The others are surviving because money is so cheap and industry does not want much of it except for refinancing and easing pension problems. Such an economy cannot cope with a serious recovery, as the resulting inflation would lead to higher interest rates, which would stifle the recovery. The American economy is in a huge impasse, and the only way out is to back out, i.e. reduce indebtedness and expand exports.

While most eyes are fixed on the USA, some quiet positive signs are emerging elsewhere. We mentioned a couple of them last week: China and neighbouring countries becoming sources of demand not just supply, and the former Soviet Union playing a similar but more modest role. This week, however, two other sources of optimism have appeared, precisely where we, and most commentators, had given up hope long ago. The first is Euroland, including Germany. The other is Japan.

We can thank Bridgewater for a brilliant analysis of European competitiveness versus US, based on share of export markets. Amazingly (given the strong euro) Euroland competitiveness is strongly rising while the USA's is declining. They point to the Airbus vs. Boeing battle as illustrative, but stress that this is a broad trend. Actually, Bridgewater conclude that US competitiveness can only return with a much weaker dollar than has happened to date, and we can hardly disagree with them.

In addition, cautious signs of improvement in the German economy are appearing. Until now, all we could say was that the much-needed reforms were happening and gave grounds for hope. Then, this last month has seen the defeat of IG Metall. While straight comparison with Thatcher's defeat of the miners may be a little over the top, a weakening of Union power in Germany can only be to the overall good. Now unemployment is on a downward trend. Not enough swallows to make a summer, but encouraging.

The change in Japan, pointed out by The Economist, is that the savings rate has dropped from a massive 23% of personal disposable income in 1975 to an (estimated) mere 2% now. That is lower than the USA's (3.5%)! The explanation is hard to discern. The most likely is that elderly Japanese, with massive savings earning very little, have realised that they cannot take it with them, and have therefore come round to the idea of spending their wealth before leaving this world. Up till now we have almost instinctively said "non-Japan Asia" when talking about growth potential. Japan might be joining the party after all!

There is a positive correlation between reduced savings rates and economic growth. However, the USA has already "shot its bolt". Despite recent rises in household indebtedness, the savings rate in the USA is gradually climbing from a very low base. That is a very different situation from Japan's, where, to push our metaphor further, the Japanese have a quiverful of bolts, while America's quiver is empty!

Overall, we strike a note of optimism this week that the long-awaited world economic rebalancing has begun, not quite as we expected (with increased US exports), but with some sleeping giants elsewhere in the world beginning to stir.

With our long-term view on investments, we address trading situations with great caution. That said, the correction on Russian bonds, which we anticipated, now looks to have run its course, and Argentina is attracting investors as the weaker domestic currency has its economic impact. Be aware, however, of very different political situations: in Russia a strong President is "taking on" the oligarchs, while in Argentina, detention without charge and a Government-placed judiciary are the order of the day.

Recommended average maturity for bonds in each currency

Our recommendation of a modest, defensive shortening in USD and EUR stands.

EUR/USD: 1.1650/1.1700 provided good resistance, and the target at 1.1280 was reached. At this level 1.1220 may offer some strong support, but a break there would provide potential for 1.1060. Resistance is at 1.1400, 1.1620, and 1.1750. Support is at 1.1280, 1.1220 and 1.1040.

USD/CHF: The corrective wave pushed the $ as far as 1.3700/50 area, and there has been a top at 1.3790. It is still difficult at this time to be sure if the long-term trend towards a weaker dollar has been broken, but we should have more clues in the next few days from the consolidation pattern now being build. In any event, the dollar is at an important level. Resistance is at 1.3710, 1.3810 and 1.3950. Support is at 1.3620, 1.3480 and1.3350.

USD/JPY: Action from the BoJ on the downside and some good selling interest have tightened the range to between 117.60 and 118.70. The long-term trend for the dollar remains bearish and the exchange rate is in a flat channel between 115/122. Resistance is at 118.70, 120.30 and 122.00. Support is at 117.60, 116.10 and 115.00.

EUR/JPY: No time to breath as the downside is definitively under way. There should now be some good support at 133.10, and a correction of the last move from 138.58 to 133.18 may take place. The next target is 135.80. Resistance is at 136.60 and 138.70. Support is at 133.10 and 132.20.

GBP/USD: the trend correction has taken place, moving the support to 1.6190. We expect a return to 1.6500/50 area. If 1.6190 holds, there is a possibility of having seen the low and 1.7000 will become the target. Resistance is at 1.6390, 1.6510 and 1.6660. Support is at 1.6190 and 1.5900.

USD/CAD: 1.3675 seems important and a close on a daily basis above that level would confirm an extension of the trend to 1.3900. Resistance is at 1.3675 and 1.3780. Support is at 1.3530 and1.3420.

AUD/USD: The end of the up-trend announced last week indeed took place, but a close above 0.66 is needed to confirm it.