Bond Outlook [by bridport & cie, February 12th 2003]

Over the years, our Weekly has become ever more critical of US economic policy. We sometimes feel like a voice crying in the wilderness. It is, frankly, difficult to hold a view contrary to so many advisers making presentations here in the world's centre for private banking. At a personal level, therefore, there came a sense of relief when 400 leading US economists also called the Bush tax cut "fiscally irresponsible", and then Greenspan last night publicly opposed fiscal deficits, fearing ineffective short-term benefits and long-term damage. He blames the geo-political situation for making things worse than they would otherwise be, while sounding a note of caution and uncertainty about what lies under the fog of war.


We find ourselves less uncertain about what lies under the fog in the US economy: a mess of deficits and indebtedness condemning the country to a poor performance for many years to come. Our view since early 2000: without rebalancing of deficits, there can be little sustainable growth and only poor returns on investment. The only good thing to point to about the US economy is a weaker dollar. It will eventually help adjust the external deficit and wean the world of dollarcentricity, but this is despite of, not because of the Administration's policy.


The common belief of investment advisers is that the USA will lead the world out of recession and that only the USA can do so. If that is true, then the world is indeed in big trouble. Japan is no candidate for leadership, since the country has never learned to import. Non-Japan Asia is likewise not ready to provide markets and is now the new source of manufacturing competition to the West (and even some service competition). The "commodity-currency" countries are just not big enough.


So what about Europe? The German giant at its centre is on its knees, and the countries soon to join are not exactly models of efficiency. The UK is significantly more pro-market, but is in danger from its housing bubble. We see the Continent as fundamentally held back by French and German policies, and by an ECB still fighting a war on inflation. Despite all that, the euro zone has room for lower rates, and increased domestic consumption. There is acute awareness in France and Germany of the need to reform labour laws and the social/pension system. Still, it takes optimism to suppose that their respective governments will be prepared to take on the entrenched union opposition to the reforms, as the Italians have.


Whether our restrained Euro-optimism is justified or not, nothing is going to happen very fast. Yes, there will be some market moves as and when war is started, but the underlying economic situation does not lend itself to quick fixes. Two massive and opposing forces are now present everywhere;


  • Deflationary forces, like spare production capacity and reduced pricing power for manufacturers, increasing unemployment and resulting labour cost moderation, non-Japan Asia as a source of foreign pricing competition, and, but for Europe only, an appreciating currency.
  • Inflationary forces, like more expensive oil and other commodities, the housing bubble, deficit spending and, for the USA, a depreciating currency.


The strength of the deflationary forces is apparent from the very fact that cheap money in the USA is doing so little to turn the economy round (the parallel with Japan is striking). However, the risk of inflation is detectable both in commodity prices and in the performance of "TIPS" (index-linked Treasuries).


Which of these two forces will overcome the other is impossible to forecast, but we can say that the odds are more in favour of inflation in the USA than in Europe, even in the UK. We therefore hold our "long maturity" recommendation for bonds in euros (as cuts by the ECB are still in the pipeline). For the USA, however, our clients prefer short maturities, although we are loath to shorten further yet. For Sterling and the Swiss Franc, there is no strong argument one way or the other.


The search for yield is still pushing investors towards corporates, with all the dangers that entails without good credit intelligence. Our long-held preference for yield via Russia sovereign and oil company bonds has been given a powerful benediction by BP's multi-billion commitment to that country.


Recommended average maturity for bonds in each currency


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

As of 22.01.03

Dr. Roy Damary

Currencies (by GNI)
The pressure on Iraq is gradually but surely increasing. With the split inside NATO, and France, Germany, Russia and China still insisting on a continuation of the inspections, all eyes are on Mr. Blix's report on Friday. As Ramadan finishes on Saturday and Bin Laden is promising to punish all countries helping the USA to combat Iraq, alerts for terrorist attacks are again at a very high level.
On the economic front, France, Germany and the UK are already in talks about softening the Maastricht criteria, with France having one of the worst industrial outputs over the last five years and Germany reporting very bad unemployment data. In the USA, deficits are on a continuous rising path. It remains to be seen how the inflation numbers are coming out this month with a still rising oil price. Most probable outcome: consolidation in a sideways market.

EUR/USD: The market is still in a correction mode, and 1.0950 is so far capping the euro below the 1.1000 barrier. The 1.0650 support zone is attracting some buying interest. Consolidation in this range is expected and only a weekly break of either levels would bring about the next movement of 100 to 150 points.


USD/CHF: Consolidation in a 1.3450 to 1.3750 range is expected. A weekly close outside this range would be needed to start the next movement of at least 150 points.


USD/JPY: With the hidden intervention policy by the BoJ, the USD/JPY managed to establish itself above 120.--. There is strong support at 119.50, and the breakout level on the upside is at 121.70.


EUR/JPY: Extreme volatility continues in this cross. The trend remains up, but 130.50 is capping any further movement higher. Downside support comes in at 129.30 and strong support at 128.80.


USD/CAD: Same comment: CAD continues its appreciation and was able to test levels slightly around 1.5100 so far. A weekly close below 1.5050 is needed for a medium-term trend change to materialise, with a price objective of 1.4200. The time may not yet be ripe. Upside resistance is at 1.5280, 1.5350 and 1.5410


AUD/USD: Same comment: key support is now coming in at 0.5780. The trend remains clearly oriented to the upside with 0.5930, 0.5980 and 0.6050 as the next price objectives



Current spot level


Current spot level

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