Bond Outlook
[by bridport & cie, October 10th 2001]
Since the sell-off after September 11, the stock market has moved
up to a level at which it now seems relatively steady until two opposing
forces resolve one way or the other: fear of further declines and hopes of
an imminent improvement. In view of the continued poor news from the USA
on corporate profits, lay-offs, not just lost confidence but real fear on
the part of the consumer and empty shops except for discounters, we can
only be astonished that the DJIA and S&P 500 are as high as they are.
The average PEs are now 23 and nearly 27 respectively, levels which just
cannot be justified when profits are declining. |
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In past bulletins we have noted the continual putting off into the
future of the recovery. It has tended to be a steady "six-months hence",
which happens to be just the right lead time to make equity investors stay
with overpriced stocks because they have all read the books that tell you
that the biggest rallies have always happened six months before the
economy starts recovering. Now, however, the lead-time to the recovery has
been pushed out at least to the second half of 2002. Commentators are
converging on a view that foresees a "small v" in nine months' time,
followed by sluggish growth. Could be. Our best guess, however, is in
favour of more declines in fundamentals and stock price levels, with only
a gentle improvement after both drag along the bottom for several
months. |
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The response of the US Government continues to be that begun the
day Bush took office: cut short-term interest rates, decrease and even
return taxes, plus (since Sept 11) increase government spending. The Fed
targets a very low overnight rate (now 2.5% and expected to go lower),
while faced with a total reversal of public financing as deficit financing
sets in. For several weeks, the yield curve has been pushed down at the
short end, with the long end also moving down, but far less so. Such a
situation cannot last when public financing is in deficit. As we noted
last week, some commentators are looking for an upturn in long-term yields
as a harbinger of economic recovery. Unfortunately it is also a signal of
inflation, a danger we still see as greater than that of deflation,
although that other real monster, "stagflation" is also lurking in the
background. |
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The Fed is currently pursuing a very tricky path. To keep the
short-end rate down, it has to buy government securities to expand money
supply (by increasing banks' reserves and therefore lending capacity). Yet
deficit financing means that the Government has to sell more T-bonds at
the longer, even much longer, maturities. That has to lead to curve
steepening with rates going up at the long end. The next step of the Fed
will then be to raise the Fed rate because inflation will have reappeared.
This scenario is one we can be confident of; its timing is another matter
altogether. For the moment a long position on the yield curve is best, but
fixed income investors must we ready to jump short with very little
notice. |
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All this affects the dollar. An overvalued dollar can survive
either a public deficit or a private one, but not both. A public deficit
demands that private savings increase, and this seems underway. The US
Government and Fed seem to be seeking three mutually exclusive phenomena:
a budget deficit, high consumer spending and a strong dollar. It just
cannot work. |
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Growth in Europe is slowing but remains positive. The ECB will
follow the Fed down with its repo rate, but Europe will not, apparently,
seek the fiscal stimulus that the USA has opted for. The euro zone will
long be plagued by having monetary policy in the hands of an ECB which may
be technically competent but is a PR disaster, while fiscal policy is
hamstrung. |
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Readers hardly need reminding that these are times for quality in
fixed income. Now that Railtrack has joined Swissair in inducing investors
into thinking that their corporate bonds had a de facto, but illusory,
government backing, appetite for corporate bonds is very low. Emerging
markets are scarcely more attractive. If investors seek yield at
reasonable risk, we can direct them today only towards Russia, for whom
economic stabilisation and growth is coinciding with closer political ties
with the West. In contrast, Argentina is wobbling again, and this time, so
soon after the last bailout, the resolve of Congress will not be what it
was prior to September 11. |
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Beyond the current military hostilities lies the unresolved issue
of Israel and the Occupied Territories. Just as only a US economic
recovery is so crucial to world economic recovery, so the hand of the USA
on the antagonists in the Middle East is the deciding factor on this
perpetual cause of so many ills |
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Recommended average maturity for bonds in each
currency Long positions should be maintained for the time
being. |
Currency: |
USD |
GBP |
EUR |
CHF |
Virtually
unchanged since 15.08.01 |
2008 |
2006 |
2011 |
2011 |
|
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It is amazing to see how all equity and forex markets have
continued to stabilise despite the air attacks carried out by the US and
UK forces since Sunday. The 3rd quarter results by the major American
companies issued during the course of the week confirm a sluggish US
economy, with no relief in sight. The US administration has revised growth
forecasts downwards for 2001 (from 1.6 to 1.1 1%), admitting that the 3rd
and 4th quarter might be in recession. It is a question of time until
Congress approves an additional $75 billion spending package to stimulate
the economy. However, it is difficult to imagine that the markets will
remain for long in this sort of consolidation mood, as further terrorist
attacks are expected in retaliation for the current bombing in
Afghanistan. |
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The G7 did not produce anything significant concerning the
evolution of the yen, implying that they approve the recent round of
intervention but are insisting that the BoJ is to act on its own. The
Nikkei is trading again below the 10,000 level, and further uncertainties
in the financial system still might block capital outflows and, even
worse, bring about yen repatriation. |
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EUR/USD: Listless trading in a
consolidation range of 0.9000 to 0.9300. Only a weekly close at one of
these levels might provoke the next movement of 100 to 150
points. |
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USD/CHF: Here as well
consolidation in a 1.60 to 1.6300 range. A weekly close of one of these
two levels might provoke the next movement of at least 150 points.
However, watch out any terrorist attacks, which would again cause huge
safe haven buying of Swiss Francs. |
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USD/JPY: Despite the fact that we
continue to favour a weaker yen over time, some consolidation in a 119 to
122. - range looks quite probable. Here also turbulence created by the
attacks definitely favour a stronger yen and only the BoJ's intervention
can prevent a sharp appreciation of its currency. |
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EUR/JPY: A broad consolidation range of
107. -to 112. 00 applies with the BoJ protecting the downside.
|
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USD/CAD: Owing to recession fears, all
commodity currencies are suffering at present. We prefer to take a wait
and see stance. Support comes in at 1.5480 and next resistance area is
1.5780. |
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AUD/USD: Broad consolidation range to
be expected between 0.4850 and 0.5050. |
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GBP/CHF: Extreme volatility will remain
in this cross and only a clear break of the resistance at 2.3850 will open
the door for its next target at 2.4100. Major support comes in 2.3550,
followed by 2.3300. |
|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.6250 |
0.9280 |
1.5010 |
121.30 |
112.00 |
Current spot
level |
1.6200 |
0.9150 |
1.4820 |
120.15 |
109.90 |
Support/Breakout |
1.5950 |
0.9080 |
1.4650 |
119.80 |
108.80 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5050 |
0.4180 |
1.5780 |
1.4780 |
295.00 |
Current spot
level |
0.5025 |
0.4145 |
1.5645 |
1.4550 |
288.00 |
Support/Breakout |
0.4850 |
0.4040 |
1.5480 |
1.4500 |
278.00 |
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