Bond Outlook [by bridport & cie, April 16th 2003]

In terms of commentators, general opinion is lining up behind the views we have expressed for many months, viz., a feeble stock market rally, a lower dollar and very little inflation. Inevitably there are those who think a recovery is likely in the US economy and the dollar, but our view remains bearish. One of our favourite commentators (Bridgewater) points out that capacity utilisation is at 75% and still declining. This means that a couple of years of "solid growth" would be needed to return to average levels (about 82.5%). We cannot see where the growth is coming from within the USA now that the whole economy is hobbled by the twin deficit, although (see below) there is some hope in exports.


Bush thinks the answer to the economic mess is to make it worse by reducing taxes and increasing the deficits. Now that people are looking beyond the war, and it ceases to be unpatriotic to criticise the Administration on anything, the voices of those who oppose the Administration's economic policy may at last be raised, and heard. The tax cuts are unlikely to pass.


The only way the USA will return to equilibrium is via a weaker dollar. We like occasionally to return to the economics of the grocer's daughter (one Margaret Thatcher): if you live beyond your means, you have to tighten your belt till you catch up on yourself. The US trade deficit for February shed a billion dollars. It might be the single swallow that does not make a summer, but it may also be the beginning of an export-based US recovery.


Two weeks ago we noticed that the US Administration appeared to have a policy of sorts, in the form of deliberately seeking to lower the yield curve at the long end, while steepening it over the first five years. Our own technical analyst has picked up the theme in drawing parallels with yield curve developments ten years ago. Admittedly the economy in those days was not "shot" as it is now, and interest rates were higher, but the similarity with the dollar's performance is striking. We observe that recent steepening has ceased between 2 and 5 years but is continuing between 5 to 10 years. Consequently the five year average maturity on dollar bonds that we have been recommending remains appropriate. However, if the historical scenario repeats itself, the steepening between five and ten years may not continue very much longer. During the flattening of the curve, which in the 1990's occurred in a bullish market for bonds, we observe that the long term outperformed the medium term. Since this technical conclusion matches apparent Treasury policy, we take this possibility seriously. For the moment, we shall leave the five year average as is, but we continue to watch the situation carefully.


"Everyone" believes the ECB must lower rates, which probably means they will, but not yet. Lower oil prices will benefit the whole Western economy. In particular they will help Europe weather the stronger euro, as raw material costs go down and a major negative component of the trade balance lessened.


"SARS" has stopped Asians travelling. It has not stopped them producing, but it does mean that trade and discussion is likely to be conducted by telecommunication rather than face-to-face discussion. The impact on the world economy is yet to be estimated, although the airlines have certainly understood very quickly! The airline bosses, that is; American Airline's staff still think they can maintain their salaries!


Three weeks ago we wrote that Brazil and Turkey had changed places in the bond market, implying that Brazil had become the favourite of the investors in emerging markets. Such has been the case, but we have to warn that too much enthusiasm could lead to overbuying soon.


Let us indulge in a little more "we told you so". Just before the Iraq war began we wrote that a quick war would make Tony Blair look a hero (they were also supposed to find weapons of mass destruction). "Hero" might not be quite the word, but it clear that he has a key role in the "kiss and make up" process the USA and Europe must now go through. Tony has played his cards very cannily, turning the UK's often derided position twixt the US and Europe into a source of political and diplomatic strength, with an impact on the UK economy that can only be positive.


The fact that the Swiss Franc appears to weakening along with the dollar (non-Swiss readers may be puzzled to read) is matter for gladness in this country!


Recommended average maturity for bonds in each currency


We maintain our recommendation for maturities in euro to average ten years. Our five years USD is still "watchlisted ten years".

As of 22.01.03

Dr. Roy Damary

Currencies (by GNI)
Equity markets are continuing their recovery and the first signs are there that certain investors are moving out of the fixed income and back into equities. Earnings are coming out slightly above market expectations, and the oil price continues in its broad USD 25 to 30.-trading range. A weaker oil price over the next couple of months would be a most welcome development for the world economy, since it should lead to a pick up in growth. Unfortunately, this might all be a bit premature and range trading is the most likely scenario.

EUR/USD: 1.0760 is the pivotal point. A weekly close above opens the door for a furter test of 1.0880 and 1.0930. Intermediate support is at 1.0710 and 1.0650


USD/CHF: As last week: after breaking the 1.3750 area, a new high of 1.4080 was reached. A weekly close above 1.4100 would speak for further USD strength, but is looking unlikely for now. Support is at 1.3780, 1.3710, 1.3650


USD/JPY: Verbal intervention continues to support the USD/JPY between 117.-and 118.--. The upside is at 119.10, 119.80 and 120.30, followed by 121.00


EUR/JPY: The 129.50 level was finally breached and, more importantly, the psychological level of 130.00 taken out. A weekly close above 130.00 would speak for further EUR strength, with 130.30, 130.80 and 131.50 as the next objectives.


GBP/USD: As before: the key level is at 1.5850. Consolidation in a 1.5500 to 1.5850 range may be expected.


USD/CAD: As we said last week, since key support at 1.5050 was broken, the CAD has remained one of the market's favourites. With the BOC lifting its rates by 0.25, the strong support around 1.4550 has been broken. Next supports are 1.4420, 1.4350 and 1.4200. Important resistance is around 1.4720.


AUD/USD: Same comment that the key level around 0.5970/0.6000 is holding for the time being. Topside, a weekly close above 0.6000 occurred and some fresh buying came in. Next objectives are 0.6130 and 0.6180



Current spot level


Current spot level

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