The optimism about a US and world recovery, seen this last fortnight, is restrained in the light of telecom problems and continued suspicion about corporate accounting. To these may be added the consideration that the chronic imbalances of the US economy remain uncorrected. Moreover, the Palestinian-Israeli conflict, the threat of military action against Iraq and unfinished business in Afghanistan, have been lifting oil prices, and raising the threat of inflation, higher interest rates and a dampening of incipient growth. Against this may be set the fact that payrolls have only just begun to pick up (by 12,000 in February), after declining for a year, and that capacity utilisation in the USA is well down. Thus, even if the double dip is avoided, GDP growth will be anaemic, and most commentators, including ourselves, see several months before the Fed raises short-term interest rates.

In Europe, however, it looks like our earlier expectation of further interest rate cuts in 2002 needs correcting. Subject to a US recovery, even modest, being confirmed, the European Commission is forecasting slow growth (after a decline in the 4th Quarter 2001) for the current and next quarter, and relatively robust expansion in the second half of this year. The contrast between the US and European economies is striking:

• The USA has sought to make debt cheap to carry for both industry and consumers, and has deliberately kept consumer spending high, seeking a pull-through effect to industry
• In Europe, interest rates, while lower than they were, are by no means at the level that lets consumers spend freely. The recovery in Europe will therefore be industry led, and it is consumers who are said not to be spending enough. (They "blew" their non-declared cash assets last year to beat the euro's arrival.)

The USA has a strong currency and a huge current account deficit. The very willingness of the rest of the world to tolerate this deficit is the main reason the USA can allow itself not to address its imbalances. A new argument is now appearing on the strength of the dollar. Conventional wisdom was that the capital flows to the USA reflected the attraction of American assets. Accordingly, the higher the US stock markets, the stronger the dollar. Yet the dollar neither weakened during the recession, nor climbed during the recent equity rally. Could this mean that the capital flows to the USA, so essential to sustain the dollar exchange rate, are now based more on the negative reasoning of "nowhere else to go" than on positive faith in the USA's opportunities. Of course, it is never a case of "either/or", but more of "both/and". The implication for the strength of the dollar is, however, that a world recovery will mean investors spreading their funds more broadly, with the net result being a decline of capital flows to the USA and a weakening of the dollar. We find the argument attractive, but it would be derailed if fears of war in the Middle East materialise.

The return of optimism in the recovery and the stock markets has led rapidly to the reappearance of complex mixed instruments with the returns a function of the future stock prices. Aimed at the retail market, they are based on counting on retail investors feeling that the risk of further falls in stock prices is now low, and on their being attracted by these "gimmicks". These instruments are a clever mixture of financial engineering and marketing. However, if retail investors only knew how to work out values on these "attractive" opportunities and how illiquid they were, they would steer clear. As usual, the only winners are the sponsoring banks and issuers. Call us if you have specific questions.

Scarcely a month ago, we thought we had detected a major loss of interest in corporate bonds. However, markets have again surprised us: new issues have increased. Spreads are down, but for investors, the additional yield, while government rates are so low, is attractive, and issuers are taking what they perceive as last opportunities to lock in low borrowing costs. Investors, when they seek more yield, tend to forget the additional risk.

US trade representative, Robert Zoellick, has put out a defence of the US steel tariffs, emphasising their three-year life and the numerous exceptions for selected countries. He claims commitment by the Bush Administration to free trade and says that all nations must improve the multilateral trading system. You can almost hear the scepticism in Europe, and our argument (last week), that US steel-using industries will pay the price, remains valid. Has he thought about how the relative value of the dollar may affect US trade competitiveness and reviewed that issue with Paul "Strong Dollar" O'Neill?

It looks like "Goodbye, Andersen", absorbed by one the remaining big four, with a bankrupt shell left behind to fend off (and presumably settle for a few cents on the dollar) the huge claims against it.

As for Japan, we have already said it countless times. The Government can play tricks, but only genuine reform can change the chronic problems of that country. Investors should not be fooled by the annual window dressing in time for the March 31st end of the financial year.

Recommended average maturity for bonds in each currency
Maintain short positions.

The main focus until the end of March remains clearly on the yen, with the repatriation process continuing. A higher stock market, helped by government assistance, an overall underweight position of the financial community towards Japan and huge stop/losses under USD/JPY 130.-- (and EUR/JPY under 114.--) were all factors contributing to a temporary appreciation of the yen. On the economic front and on the reforms of the banking sector, the outlook remains very bleak and it is therefore hard to imagine that the current JPY strength will last much beyond end of March. Mounting tensions in the Middle East, coupled with higher oil prices and a growing probability of an US attack on Iraq might well speak for a higher CHF. With the market overall long EUR/CHF, we see a clear danger of a higher CHF in the foreseeable future.

EUR/USD: Consolidation in a 0.8550 to 0.8750 range for the time being. Only a clear break of 0.8830 or 0.8480 would bring about the next movement of 150 to 200 points.

USD/CHF: The US unit has clearly shied away from its break out level around 1.7250; resistance is now at 1.6950/1.7000, and support at 1.6720. A weekly close below would open up the door for a move down to 1.6550.

USD/JPY: Having broken the psychological barrier of 130.00 (not our preferred scenario), this pair has moved into a new trading range of 126.50 to 130.--. A move below 126.50 would be catastrophic and speak for a much higher yen with 120.-- not impossible (again not our preferred scenario). A weekly close above 130.40 is needed to regain confidence that the yen is on weakening path again.

EUR/JPY: We have been stopped on half of our long EUR/JPY position at 112.80 (loss 150 points). Broad consolidation now applies in a 111.00 to 115.00 range. A clear break of 110.00 would be catastrophic and open the door for a much higher yen of 105.-- (not our preferred scenario). On the topside, a weekly close above 115.30 is needed for the market to gain confidence that the yen is again on a weakening path.

USD/CAD: We are keeping our short position USD/CAD at 1.5955 with a S/L at 1.6300. The price objective is still around 1.5650.

AUD/USD: Higher commodity prices are giving some support to the Aussie. Major support is at 0.5050. A weekly close above 0.5280 to 0.5330 would open the door for higher levels, with next objective of 0.5450.

GBP/CHF: The big trend line support around 2.3850 has been broken, opening the way for the next move down to 2.3550 followed by 2.3300. On the topside, GBP needs to break 2.3850 again on a weekly close to head for levels above 2.4000.