BRIDPORT INVESTOR SERVICES WEEKLY
 

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!

 

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.

 

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.

 

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:

 

  • 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).

 

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.

 

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.

 

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.

 

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!

 

Recommended average maturity for bonds in each currency

 

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

Dr. Roy Damary


Currencies (by GNI)
 
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).
 

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.

 

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.

 

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.

 

EUR/JPY: Same comment: broad consolidation in a 126.00 to 130.50 range, testing the upside again.

 

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.

 

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.

 

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.

 

 

USD/CHF
EUR/USD
EUR/CHF
USD/JPY
EUR/JPY
Resistance/Breakout
1.3380
1.1080
1.4720
117.80
129.65
Current spot level
1.3285
1.1045
1.4670
117.20
129.35
Support/Breakout
1.3250
1.0980
1.4610
116.80
128.80

 

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
1.6135
350.00
Support/Breakout
0.5950
0.5480
1.4650
1.6010
345.00
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