Bond Outlook [by bridport & cie, October 15th 2003]

A play within a play, everyday "life as normal" events, while massive shifts are taking place in the world's politico-economic balance. Thus do we see the two "tableaux" of the economy and financial markets today:


  • The micro-tableau: in which the easy monetary policy, weakening dollar and deficit spending (beyond what even Keynes could have considered) are supposed to continue to revive the US economy at least till the Presidential election. Questions are at the level of "Are the improvements in corporate profitability durable?" "Will the stock markets continue to rise?" "Will the USA, with its massive demand for goods and services, help all other economies expand?"
  • The macro-tableau: which has the world undergoing a massive shift from a mono-polar economic structure to at least a tripolar structure. Now the questions are: "Is US economic power waning in favour of Asia's?" "Is the dollar losing its privilege of being the sole reserve currency by sharing this role with the euro?" "Will Japan, China, Russia, other former Bloc countries, other Asia, and even Germany, provide demand for the world's goods and services to replace the USA's?"


To help us deal with these two tableaux, we are grateful to John Maudlin who has given us the concept of "ought to" in economic analysis. "Ought to" itself has two dimensions. One is purely mechanistic, for example, "if PEs are again at record highs, the stock market ought to fall back to much lower valuations". Or, "if the dollar is weaker, exports ought to pick up and imports decline". The other has moral connotations, such as "no country ought to live beyond its means", or, "no government ought to spend massively more than it raises in taxes".


Our belief is that the "mechanistic" and the "moral" are not so different, and are both expressions of market forces, which means that they will eventually have their expected impact (rather like the tide coming in, to refer to an earlier simile of ours). Yet in the meantime, the "play within a play" continues, and money is being made on the stock markets and yields on bonds are rising on both sides of the Atlantic.


In terms of relative currency strengths and macroeconomic balance, Euroland interest rates ought to move in the opposite direction to the USA's, but so far such decoupling has not occurred. Our recommendation a fortnight ago modestly to move out on the yield curve in EUR and CHF reflected our long-term belief that decoupling will eventually occur.


In the corporate news this week there was flicker of corroboration of the shift to a wider base of demand growth. Intel, in announcing positive sales and profits data, explicitly stated that much of their expansion came from China, India and Russia. Likewise, China is importing massively from Japan and Taiwan.


The USA, and specifically the current Administration, will one day be called to account for profligacy. The fear is whether this will drag the rest of the world down, a fear so great that China and Japan (and the UK?) are conniving to delay that day. Our hope is that the shift in demand will allay that fear, remove the motive for these three countries to intervene in currency markets, and endorse a weaker dollar being the first step to global rebalancing. A revalued renminbi would be a second step.


A consequence is that we remain cautiously optimistic about emerging market bonds.


To finish on a further comment about the micro-tableau, Stephen Roach (MSI) points out that consumer durables have boomed for two quarters and cannot continue their role as a demand motor. We see the short-term boosts of re-mortgaging and tax rebates as just about over. We therefore maintain our scepticism about the durability of the recovery, even within the rules of the micro-tableau analysis.


Recommended average maturity for bonds in each currency


Generally stay short, but new cash going a little longer in euros and Swiss Francs.

As of 01.10.03
As of 30.07.03

Dr. Roy Damary
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