Bond Outlook [by bridport & cie, December 12th 2001]

The six-month theory still reigns. Just! Expectation of a recovery in early Summer 2002 is keeping plenty of interest in equities even as the two leading US indices struggle around levels of 10,000 and 2,000. The argument is also presented, and it is somewhat circular, that stock markets uncannily anticipate economic recovery ahead of boring old fundamental measures like unemployment and profitability. Optimists are counting on huge liquidity, fiscal stimulus and low oil prices to provide traction, all in a positive political environment as the War on Terrorism goes well.


More and more commentators, supporting the direction we have taken in this weekly over the last several months, are expressing a more pessimistic view. In particular, they are seeing a parallel between the early 1930s and the current:


  1. O'Neill is acting like a latter-day Hoover with his "prosperity is just around the corner".
  2. The booms of the 20s and 90s were both unnaturally prolonged, postponing and prolonging the clean-up of the excesses built up during the bubble.
  3. The "treatment" by the US Government is the same, money and fiscal loosening, but it took years for the 1930s economy to recover.
  4. The 1930s depression was world wide, with no one able to lead the way out (international trade has almost stopped growing as of 2001/2).


We would not want to say that today is a repetition of the 1930s. That would be too extreme, just so long as serious deflation is avoided. Yet the description of today as being a "post-bubble economy" looks perfectly appropriate, with all that implies about the time required for recovery.


A month ago, we finally put a date on when we expect an economic recovery. We said end 2002. A new analysis has reinforced this view. If the first interest rate cut is taken as "time zero", and then unemployment plotted against time since then, it turns out that today's US unemployment trend is tracking closely (a little worse currently) the average of previous declines in the economic cycle. Unemployment rises for a full year, stays at a high level for a further year, and then, two years later (which will correspond to New Year 2003) begins to decline.


Are you still confident of the six-month rule? Add to the above the fact that US capacity utilisation, now at its lowest since 1983 and still going down, has never taken less than a year to return even to average levels. The Fed does not tighten until capacity utilisation is above average. As to the link between fundamentals and stock prices (which have proven very elusive recently!), we again point out that PEs are higher than at the peak of the bubble. Tech stocks are supposed to lead the recovery, yet overcapacity in telecoms will take years to absorb. The launch of the XP operating system is not having much impact on the demand for personal computers. Enron was not only an energy trader; it had also built a multi-billion white elephant broadband network. So has Dynergy, Enron's erstwhile suitor. A case of newcomers utterly wrecking any chance of established players sensibly building capacity to match demand.


Since our last weekly, both the Fed and the SNB have indeed cut rates, and the wording of the Fed's announcement implies a further 0.25% to come in the New Year. After that, there is little room to go further. Either the six-month rule will prove correct, or our view will pertain of a long period of "going nowhere fast" with modest pick up in a year. Rates will not be increased till that capacity is used, i.e. a long period of low interest rates is ahead of us, with Europe moving down next year to levels nearer the US rates. The recent rise in long-term rates frankly took us by surprise. We see it as an oversell situation, and note that long-term rates tend to move nearer short term over time (and time there will be). Moreover, a partial explanation for recent bond-market behaviour may be found in Deutsche Bank's manoeuvres to protect US corporate clients against possible interest rate rises.


In emerging markets, Argentinean contagion is proving limited to Brazil so far.


In Europe the whole issue of illicit cash being spent and the euro's arrival will make interpretation of economic data very difficult for a few weeks. In the meantime, the weak-willed yielding of the French Government to public sector unions is very bad news. Inflation would normally result, but now seems unlikely. It can only mean increased taxes or deficit financing for France, and a worsening economy.


Recommended average maturity for bonds in each currency
We leave our recommended average maturities at a little under five years.

Over the period 15.08.01 to 21.11.01
As of 05.12.01

Dr. Roy Damary

Currencies (by GNI)


Same comment as last week: we are now entering into the pre-Christmas market with liquidity becoming very thin. It looks like Central Banks are supporting the euro below 0.8800. This may be because they wish to avoid bad publicity with the introduction of the euro at the beginning of next year. As we said in our comment last week, the SNB did cut by 0.50% and the Fed by 0.25%. There are very mixed figures out of the USA, with certain parts of the economy showing signs of recovery, but in a environment of rising unemployment and long-term interest rates.


EUR/USD: euro support comes in now at 0.8850 but 0.8980 to 0.9010 is still acting as a major resistance, which needs to be broken on weekly basis in order to make further progress on the upside. Key support is at 0.8750.


USD/CHF: Same comment: the 1.6480 to 1.6530 area remains key. A weekly close above this is needed to retest the resistance at 1.6750 to 1.6800. The downside remains open with 1.6420 to 1.6380 acting as very good supports, followed by 1.6250. Keep in mind that this currency pair remains extremely volatile.


USD/JPY: Economic data coming out of Japan are getting worse and worse, bankruptcies are increasing and more and more voices in support of yen depreciation are putting the currency under huge selling pressure to approach retesting the USD/JPY highs at 126.60 seen at the beginning of the year. In the short term, there might be a slight technical correction with supports coming in at 125.50, 124.60 followed by 123.50. On the upside, resistances are at 126.60, 127.80, followed by 129.00.


EUR/JPY: With the break at 111.30, short-term our target of 113.00 has nearly been reached. Downside, a major support area comes in between 110.00 to 111.30. Medium term, we expect the yen to weaken further and to be heading for 115.00 at least.


USD/CAD: our price objective of 1.5650 has been reached and we took profit on our long CAD position established at 1.5990 (340pts). So long as the rate stays below 1.5780, the upside looks quite limited and further advances in the direction of 1.5550, followed by 1.5480 are quite probable. Short-term consolidation may be expected.


AUD/USD: Same comment: the Aussie has created a solid base above 0.5000, and solid support comes in already at 0.5110. The topside should be limited to the 0.5280 to 0.5310 level.


GBP/CHF: Extreme volatility in this cross will continue. A broad trading range is developing between 2.3100 and 2.4100.

Current spot level
Current spot level
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