Bond
Outlook [by bridport
& cie, March 12th 2003]
We have argued for so long in favour of defensive investing, with
emphasis on the euro and the Swiss franc, that it is difficult to say new
things after the markets have moved very much as we supposed.
Nevertheless, we shall try! |
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The threat of war with Iraq was once just providing a covering of
the real economic situation, but has now moved to having direct impact -
clearly very negative. That is obvious. Less obvious is what to expect
when the war is over or averted. |
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The common opinion is that there will be a rebound in shares and in
the dollar, and a move out of the safe havens of both high quality bonds
and cash in EUR and CHF. If the pattern of the last Gulf war is followed,
the rebound could happen when the war begins, in anticipation of a quick
conclusion. All this, of course, is in the future. As we write, the market
is still moving towards increased defensiveness. Our recommendations on
maturities and limiting exposure to corporate bonds remain valid. Most of
our clients are not really positioning themselves for an equity rebound,
although the larger base of investors may be. We have seen an element of
bar-belling, so that cash is available quickly, but with bets very much
hedged. |
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Our best estimate: that the rebound will happen, but will have very
limited potential. To reasons we have long identified (US deficits,
over-indebtedness, over-valued markets, spare production capacity,
external downward pressure on prices), may now be added: |
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- Huge and growing
state and municipality deficits
- Doubts about the
financial solidity of the US mortgage agencies
- Still more evidence
of pension fund shortfalls (e.g. GE's $ 5 billion make-up contribution)
- Fears about credit
derivatives and their impact on banks and insurers (as highlighted by W.
Buffett)
- Political struggle
about putting through tax cuts in a time of ballooning deficits
- Increased costs for
staff (health care, less use of stock options for remuneration)
- Several airlines
about to go broke
- High oil prices
(but this variable is linked to the war).
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All this in a situation of a serious family fight between parts of
Europe and the USA, which will inevitably damage trade and investment
relations no matter the outcome at the UNO and on the ground. Lest we
forget (from seeing only the "Administration's" view in the public media),
America itself is now deeply divided over the Bush policy on Iraq.
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From the above, it can be no surprise that we do not believe the
rebound will have much strength or durability. Commentators in a few weeks
will ask whether it is time to return again to defensive positions.
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Are there likely to be long-term changes because of the "family
fight" over Iraq? Yes, but it is because the division of opinion
reinforces a trend linked to the dollar seeking more realistic values. The
high degree of dollar centricity in trade and wealth holdings is changing
in favour of the euro as a second core currency. Frankly, we expected this
to happen long ago, and were mistaken in our timing, but the trend is now
firmly under way. Arabs seem to have been the first to reduce dollar
holdings. Now, Russians, who are huge holders of dollars (in cash and
banks), are seriously using the euro as an alternative. They are even
stating publicly that the Government is worried about the rouble
strengthening! China has gone public in stating that it will diversify its
reserves. Dollar issuance in corporate bonds has greatly declined in
favour of the euro, with even Fannie Mae now joining the trend to issue in
euros. |
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An FT letter claims "dollar doomsayers will be wrong again". It
refers to the USA "shouldering the burden of holding up the world
economy". Is the USA "shouldering a burden", or abusing the privileges of
having the world's leading reserve currency? Either way, dollar
de-centricity will mean that the over-consumption by the USA of the
world's production will decline. On the assumptions that Japan will not
reform, that China will be slow in opening its markets, that no other
economy has the size to provide lift, there remains but Europe to provide
expanding markets. Hang onto that hope, difficult though that may be when
you see Germany, it is the best we have! |
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Recommended average maturity for bonds in each currency
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We maintain our recommendation for maturities in euro to average
ten years. |
Currency: |
USD
|
GBP
|
EUR
|
CHF
|
As of
22.01.03 |
2008
|
2008
|
2013
|
2008
|
|
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The calm before the storm. The US unit is consolidating at very
depressed levels, without moving to any new lows ahead of next week's
expected breakout of war with Iraq. Equity markets continue to slide. Only
some profit taking gives the dollar a small lift from time to time in a
still bearish USD environment. For market participants wanting to play a
short-term USD recovery, we would strongly recommend buying USD calls up
to one month (since volatility is low, both call and put options are quite
cheap). |
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EUR/USD: 1.0950/80 is providing crucial
support and 1.1080 very strong resistance. Consolidation in this range is
expected, with a break on either side likely to cause a move of at least
100 to 150 points. |
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USD/CHF: Short-term consolidation is in
a 1.3250 to 1.3380 range. A clear break on either side should bring about
the next move of at least 150 points. |
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USD/JPY: Same comment: capital
repatriation is still reinforcing the JPY. Currency intervention is
putting a temporary floor at USD/JPY 116.50. A weekly close below this
would open the door for 115.00. Upside resistance is at 117.80, 118.20 and
119.50. |
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EUR/JPY: Same comment: broad
consolidation in a 126.00 to 130.50 range, testing the upside again.
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GBP/USD: Key level is at 1.5850, this
time with a test of 1.6150. Next resistance is at 1.6180, 1.6250 and
1.6310. A clear break of support at 1.5850 would again lead to a sell-off
down to 1.5650. |
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USD/CAD: Same comment: so long as we
stay below the key resistance of 1.5050, the price objective remains at
1.4200, with 1.4700 having already been tested. The trend remains your
friend. |
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AUD/USD: Key support is around the
0.5970/0.6000 area, with 0.6180 tested so far. A weekly close below the
support of 0.6000 could trigger more profit taking down to the 0.5880
area. |
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|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.3380
|
1.1080
|
1.4720
|
117.80
|
129.65
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Current
spot level |
1.3285
|
1.1045
|
1.4670
|
117.20
|
129.35
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Support/Breakout |
1.3250
|
1.0980
|
1.4610
|
116.80
|
128.80
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AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.6080
|
0.5580
|
1.4810
|
1.6180
|
358.00
|
Current
spot level |
0.5990
|
0.5500
|
1.4745
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1.6135
|
350.00
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Support/Breakout |
0.5950
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0.5480
|
1.4650
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1.6010
|
345.00
|
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