Bond Outlook [by bridport & cie, May 14th 2003]

We have two major preoccupations this week, first the dollar and then emerging markets.


A weaker dollar is a crucial ingredient for the rebalanced world economy that we have seen as both necessary and, in the longer run, inevitable since the end of the hi-tech bubble. The American Administration has managed to proclaim a strong dollar policy, while bowing to or even encouraging market forces to the contrary. Maybe they see the need to avoid too much of a good thing. Certainly other countries' central banks are attempting to slow the decline by both words and (according to our GNI friends) market intervention. Most countries can indeed make their currencies "half-follow" the dollar down. The exception is the euro, because it is taking on the nature of a reserve and trading currency, with all the burdens and responsibilities that implies.


What does "too much of good thing" mean? It means a dollar crisis; that the inevitable overshoot of the dollar on the way down will turn into a rout as holders of dollar assets, even the Japanese, tire of seeing them devalue. The dollar bottom is still some way off, as is the positive impact of a lower dollar on the American current account. We were far too optimistic last month when it appeared that the US trade gap was narrowing. We should have remembered that, first, imports cost more, and only second do exports increase. Initially, then, the trade gap will widen (pushing the dollar overshoot on the downside), before an eventual narrowing. The damage done by the US Administration's economic policies took years to inflict, and will need years to repair.


There is a major motive for the "say one thing, do another" policy of the US Administration. It is "Get Bush re-elected". This implies an 18-month time horizon, with corresponding laxness on money supply to keep the consumer spending despite the price to be paid after the election. The Democrats, with their negligible contribution to the debate about policy, are so far doing all they can to ensure George W.'s re-election. They even make Ian Duncan-Smith look like a creative and effective Leader of the Opposition (if you do not know who IDS is, no matter!).


Our other concern is about the spreads on emerging-market bonds. Led by Brazil and Russia, they have been narrowing steadily, with even Argentina caught up in the enthusiasm. Brazil's case seems to be built on the fact that Lula has done nothing (neither good nor bad), whereas markets feared he would only do something bad. Russia's improvement is based on firmer economic fundamentals and a widely recognised improving credit risk. Nevertheless, the search for yield in fixed income looks very much like creating an over-bought situation in emerging markets, with even our favourite, Russia, in danger of a correction. What a sign of the times it is that both the Russian and the Brazilian Governments are struggling against their currencies rising against the dollar!


Another positive long-term effect of the weakening dollar will be the pressure on "unreformed" Europe to tackle the problems of high social charges, discouragement of enterprise and the resultant high unemployment. It is a source of continued wonder to us that the French population as a whole support the public sector strikes against pension reform. How can the three-quarters of the French working population in the private sector stomach the totally unfair and unjustified pension privileges of the public sector? How can working adults of today be so thoughtless in their demands about retirement age and pension guarantees, when the price will surely be paid by their children? There is a curious parallel with the USA's implicit policy of "let the next generation pay for today's excesses!" A key difference, however, is that the French Government, if not the people, has recognised the need for reform. As in Germany, the reform is a long way from implementation, but at least the subject is on the table, very badly explained to the population at large, but on the table. In the USA, even that is not the case.


Trade wars loom between the USA and the EU, SARS has stopped China in its tracks, Terrorists prove they can still murder. Maintaining optimism is a challenge indeed!


Recommended average maturity for bonds in each currency


Stay long in dollars and euros, yields have to decline, except where the US Treasury issues (2-7 years).

As of 07.05.03

Dr. Roy Damary

Currencies (by GNI)
The US wants a lower USD, Japan wants a lower JPY, and Europe has been happy so far with an appreciating euro "to fight inflation". With Mr. Bush aiming at his re-election, the rising twin deficits and a still very mixed economic picture, strong voices are again calling for the FED to cut interest rates further. The ECB is expected to cut on the 5th of June, but is not yet known whether they will opt for a prudent 0.25% cut or a more aggressive 0.50% to give the market a stronger signal. Short-term consolidation is underway, owing to profit taking on short USD positions, but no trend change is expected for the time being. Beware of a potential USD crisis, especially if the FED acts before the ECB.

EUR/USD: The 1.1630/50 level is currently blocking the upside. Only a clear break would push the euro in the direction of 1.1750/1.1800. A move below 1.1450 would open the door for a correction down to 1.1300, where some renewed buying interest would come in again.


USD/CHF: After testing a low near 1.3030, the US unit managed to return to levels slightly above 1.32. A weekly close above 1.3230 would be needed to speak of the next correction target of 1.3410. Any loss of the psychological barrier at 1.30 would send the dollar quickly towards 1.2800.


USD/JPY: The BoJ continues its hidden intervention process to prevent USD/JPY from moving below 115.50. Consolidation in a 116.00 to 117.50 range is now expected. There is need for great caution at 115.00


EUR/JPY: 133.50 remains the key support level. A clear break would send this cross fairly quickly in the direction of 131.50. Topside resistance is at 135.50, 136.20 and 137.50


GBP/USD: The support level moved up from key 1.5850 to 1.6000. So long as the rate stays above 1.6000 level, the next levels are 1.6150, 1.6230 and 1.6350


USD/CAD: 1.4030 remains the key resistance on the upside. So long as the rate stays below this, support comes in at 1.3830, 1.3750 and 1.3680


AUD/USD: Our target of 0.6350 has been reached and is acting as a major support now. Topside is at 0.6480 followed by 0.6550.



Current spot level


Current spot level

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