"The stock markets have gone up because the economic news is less bad than expected". That is about as close as we can get to a rational explanation of a huge rally in stocks over this last week. Had any of us been looking at economic news in isolation of stock market performance, we would been faced with making a judgement based on facts like:

• Falling US retail sales overall, but with some retailers reporting a "pick-up in traffic". Nominal sales lower than real volume as retail prices are declining.
• Consumer sentiment worsening (to 80.4 from 86.1 in September), although this measure was taken before the rally.
• Layoffs now moving from small companies to large employers, led by GM and Ford. Unemployment growing more slowly, but with a high of 7.6% now in sight.
• Manufacturing output and orders the subject of contradictory measures and outlook, some suggesting a rise in the last quarter of the year, others suggesting further retrenchment.
• Suspicions of easy credit coming to an end undiminished.

Add to this, the return of Al Qaeda, the ongoing threat of an Iraq war, a sniper in Washington, and, particularly worrying, Paul O'Neill assuring us all that the economy is on a sound footing, and it would have been difficult to expect a stock market rally. Yet, there was a strong one, and we are forcibly reminded that stock markets may be quite dissociated from fundamentals in the short and medium run. We are also reminded that meaningful rallies always happen in the midst of a bear market, and it is technical analysis that proves the better at detecting them. Thus we take our hats off to our clients who took profits on bonds, as reported last week.

The PE ratio for the S&P 500 index has gone back up to 32, which is over twice the historical average. Corporate bonds have only weakly benefited from the stock market rally, implying that all the above fundamental considerations are still on the minds of fixed-income investors.

Other clients, not rising to trading opportunities, are still lengthening in the expectation of further cuts in interest rates. All the evidence points in that direction, with, for example, the new German Government now pressuring the ECB to cut rates.

The emerging market is dominated by the expectation of a Lula victory in Brazil, even to the extent that Turkey has largely been forgotten. However, that country, too, has an election and an IMF deal. Despite the rejection of Turkey's application to the EU, the country remains an indispensable part of NATO and the West. With the Real trading at close to 4 to the USD, there is a chance that Brazil may export its way out of its predicament. At a yield of 26%, the brave may consider Brazilian sovereigns for a punt.

The Bali atrocity should result in consolidating worldwide collaboration and determination to fight terrorism (as distinct from seeing it as Al Qaeda versus the USA), and it may remind the Bush Administration not to let Iraq take their eyes off the active enemy.

If this rally is, as we suspect, a false dawn, the dangers of an even more serious recession are significant. Even as Citibank reported increased profits after selling a building for $1 billion, and achieving some increase in consumer lending, it added nearly $ 300 million to its bad loans reserve, while Bank of America declared increased non-performing corporate loans. Corporate America is still vastly over-invested and over-indebted а la "Austrian Economists' recession", while consumer spending, which we have always regarded as an inadequate, even an irresponsible, route to economic recovery, is now wobbling. The tragedy of a rally like this week's is that it delays the inevitable. As in 1999, we find ourselves to be party-poopers, rather like the little boy who exclaimed that the emperor had no clothes.

The vote in Ireland looks very close. Will they upset the EU applecart twice running?

Recommended average maturity for bonds in each currency.
Remain long across the board, except in Sterling

Four days of rally in a row for the US stock markets have given some strength to the Greenback. As expected, the ECB and BoE held their rates steady last week. JPY has fallen further, and Hayami (BoJ) thinks that at this level the yen should weaken no further.

EUR/USD: The euro continues to develop "sideways", range bound between 0.9955 and 0.9750. Only a weekly close outside this range should announce new targets (0.9600 and 1.0150). We incline to the bearish scenario.

USD/CHF: As for the euro, even if some daily moves are interesting, the medium-term pattern is not very exciting. The exchange rate remains between 1.5050 and 1.4750. With the recovery of the US stock market indices, a stronger dollar and a break of 1.5050 to target 1.5200 seems the more likely to us.

USD/JPY: The first resistance at 124.80 has been triggered. We would now expect the rate to go higher, with a first objective at 125.90. We would reverse this view should the rate drop below 123.00.

EUR/JPY: Consolidation is in a 120.00 to 122.00 trading range. Major support is at 119.50. The trend remains towards the upside.

USD/CAD: The CAD continues its weak behaviour as it tries to establish itself above its support of 1.5780, but with the 1.6000 area remaining in view. We still prefer to wait until we have a clearer view of how the US is going to perform economically before establishing our long CAD/short USD position.

AUD/USD: Same comment: it looks like the Aussie is still struggling to sustain levels above 0.5500 for any length of time. Consolidation in a 0.5350 to 0.5550 expected until further notice.