Bond Outlook [by bridport & cie, January 16th 2002]

Last week we identified three seminal events for the start of 2002 (Argentina, the euro and the yen), all of which are still playing out. We should have added a fourth: Enron. Last year we had already questioned the way the auditors were able to take gigantic fees for audit and for consultancy, but totally fail to signal wrongdoing. It now appears that the imbrications of Andersen with the Enron management was greater than anyone could have imagined, with the auditor admitting document destruction on a grand scale once trouble started, even after the sub-poena. Andersen is dismissing staff directly associated with the Enron assignment, but it remains to be seen whether the company's other clients are unperturbed.


The repercussions of the Enron collapse extend to the rating agencies, which are in an intolerable position when a downgrade itself becomes the trigger for bankruptcy of the company rated. On the political front, the Democrats will seek to tarnish the reputation of the Bush administration (revenge for White Water and even Monica Lewinsky). On pension rules, the Americans will finally follow the Europeans (remember the Maxwell case) in limiting a corporate pension fund on holdings of its own corporations' shares. Auditors will certainly have to take their role of investigators more seriously, and may have to shed still further their consultancy arms. What a shame that the person in charge of reviewing the pension and financial disclosure issues is one, Paul O'Neill, whose statement that "The Enron collapse is part of the genius of capitalism" deserves to be his political epitaph.


The same O'Neill continues to preach a rapid and strong recovery of the US economy, and enough people believe him for him to influence markets in the short term. The National Bureau of Economic Research does not agree with him. It cannot even pronounce that the US economy will soon reach its trough. Neither does Greenspan agree with O'Neill. He has begun interpreting the economic statistics much along the lines we have been saying for months, viz., that recovery is to be sought in industry not in consumer spending, and that unused capacity must first be used up before investment can move forward.


Thus the struggle for the mind of investors continues in the USA between the political optimists and the economic realists. We align ourselves with the latter, seeing therefore interest rates as liable to further cuts followed by many months at the same (low) level. There will continue to be fluctuations in bond prices reflecting who spoken loudest or last about the timing of recovery. Then one day, which we still see as at year's end, the recovery really will come. All this means that it will be a difficult year for bonds (although equities are likely to be even more difficult). Bond investors will, like us, have to remain very attentive to changes in the shape of the yield curves. Our recommendation to remain short for institutional portfolios stands, and we stress the need for great attention to credit risk.


The performance of the euro against the dollar is disappointing and challenges even our faith that the currency should rise as the currency becomes a part of the reserves both of individuals and governments. In the meantime, the proposed "revisit" to the European takeover code, sabotaged last year by German resistance to change, is encouraging. German companies have at least (and at last) understood the advantages of focus, as they have begun significant unwinding of cross-shareholdings now that the capital gains tax has been eliminated. What a pity that the French Government is continuing to impose what are supposed to be job protecting regulations, but which merely make France less attractive for investments and therefore job creation. However, the employers' federation managed to take some of the sting out of the labour restrictions proposed by the Jospin Government.


The risk of Argentine contagion has not completely disappeared as recent days have seen a widening of emerging market spreads, but nothing of disquieting levels.


If you ask just what country is the biggest drag on the world economy, and is likely to remain so for years to come, it is Japan. The devaluation, now slowed by Chinese complaining, may help, but the fundamental problem of massive bad debt in the banking system is still not being attended. We enjoy parallels:


  • The USA is focusing on consumer spending when the bigger problem is industrial investment
  • Japan is focusing on reversing deflation while the bad debt issue demands attention also.


One last question: 'If US retail sales are so great, why is Kmart going broke?'


Recommended average maturity for bonds in each currency
We leave our recommended average maturities at a little over four years. Clients are staying short, some even moving to floating notes.

Over the period 15.08.01 to 21.11.01
As of 05.12.01

Dr. Roy Damary

Currencies (by GNI)


Japanese Prime Minister's Koizumi's recent visit to most other Asian Pacific countries to talk about the difficult Japanese economic situation also sought to play down the impact of the recent yen weakness. After concerns by Malaysia, Korea and China, the Japanese think that a gradual and parallel depreciation of these currencies along with the yen would be the ideal solution in order to remain competitive in the export industry. Out of the USA, there are still a lot of mixed economic figures, and Fed officials talk rather about "modest recovery" to take place by the second half of the year.


EUR/USD: 0.8850 was finally broken and a low of 0.8804 has been tested so far. A weekly close below 0.8810 would open the door for 0.8750, 0.8680 and 0.8550. Resistance on the upside is 0.8880, 0.8980 and 0.9030


USD/CHF: The US unit also tested a high of 1.6725 with the big break out level on a weekly basis at 1.6780 followed by 1.6900. Support comes in at 1.6500 followed by 1.6380


USD/JPY: After having failed a couple of times above 133.00, the exchange rate still consolidating around 131.00. This correction could go on; the next important levels on the downside are 130.30 followed by 129.00. We still believe in medium-term yen weakness with our price objective of 136.90-


EUR/JPY: After failing to sustain levels above 119.00, heavy profit taking and S/L have pushed this parity to a low of 115.65. The zone between 114.70 to 115.10 is extremely important. Any loss would put heavy downside pressure on this cross. On a medium-term basis, we still think that levels around 115.00 represent a good buying opportunity.


USD/CAD: We keep our short position USD/CAD at 1.5955 with a S/L at 1.6300. Price objective is around 1.5650.


AUD/USD: The Aussie has created a solid base above 0.5000, but needs to break 0.5280 on a weekly basis to make further progress direction 0.5400.


GBP/CHF: Extreme volatility will remain in this cross and only a clear break of the resistance at 2.3850 will open the door for its next target at 2.4100. Major support comes in 2.3550, followed by 2.3300.



Current spot level
Current spot level
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