Bond
Outlook [by bridport
& cie, June 18th 2003]
This week we write from Moscow, which gives a certain distance to
events in the USA and Western Europe. The weakness of the dollar and the
gyrations of the stock market concern Russians very little as they get on
with making money. Funds are now flowing back into the country for
investments. The private sector is booming and gradually taking over the
remaining state assets. Macro-economics are strong: reserves are growing,
inflation is too high (mid-teens), but at least deflation is no threat,
and expansion is now based on productivity improvement as spare industrial
capacity has now been largely used up. Of particular interest to the
fixed-income sector is the emergence of a local bond market at affordable
interest rates (less than inflation, actually), along with consumer
credit. Defaults on rouble bonds are expected at any time, but with a
sense of testing the system. If the bankruptcy laws work and defaults are
handled smoothly, the country will have made a further step to
normalisation, and have had a first lesson in risk assessment for
corporate borrowing. In fact, risk assessment and matching assets to debts
by the banking industry seem to be the main problems. Sperbank is held up
as a dangerous case of borrowing from the public to lend to industry.
Banking reform remains a major need but politically difficult (just like
in Japan!). |
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Overall, then, Russian economic recovery looks real and to be based
on positive fundamentals. Contrast the USA, where hype and spin rule the
day. What about this for an example of hype: inflation went up from 1.5%
to 1.6%, so the dangers of deflation have gone away. Have you noticed why
prices went up? It was because of hotel costs and the New York Subway! The
market promptly priced in a 25 bps cut in the Fed rate in June in place of
a 50 bps cut. Unemployment is still increasing, industrial capacity usage
remains at a twenty-year low of 74.3% and the pricing power of producers
is as weak as ever. No, we do not think the price of a New York Subway
ticket is driving away deflation! We do however think that the weak dollar
will keep deflation at bay, or rather, export it to Europe. All in good
time, that is. For several months yet, for we expect inflation to be so
low and economic growth so weak that interest rates will continue their
downward trend. Dollar yields have bounced off their lower trend line, but
the trend line is still downwards. |
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The very idea that an economic recovery can be brought about by
flooding the country with money when the external deficit is enormous is
absurd. This policy is based on the curiously American idea that recovery
has to be led by consumer demand; if demand is too low, it suffices to
make credit cheaper and easier and thereby increase it. However, if the
subsequent demand goes first and foremost to imports, and neither capacity
usage nor profits in domestic industry improve, maybe the treatment does
not fit the problem. There is one trough and three piggies. The third
piggy, industry really does not have much incentive to compete with the
Government and the Consumer for borrowing, as profitable returns look so
unlikely. In 1931 Keynes pointed out that business investment depends on
the hope for profit. A small increase in prospective profits and the
investments do not happen. "This, unluckily, is just what has happened",
and, unluckily, Keynes' 1931 comment applies in 2003. Corporate profits as
a proportion of US GDP are at a stubborn 8%, and they are only being kept
there by continual cost cutting. That is the basic danger of deflation: it
kills profits, which in turn kills investment. |
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As we have written before, Europe is not subject to the same "hype"
as the USA. The economic situation is poor in the heart of Europe and no
one denies it. Two great battles for reform are now underway: one in
Germany over social security costs, and which Schroeder appears to be
winning, and in France over pension reforms, especially in the public
sector. At last some French-language commentaries are doing the rounds on
the Web pointing out just how molly-coddled public sector workers are, and
encouraging the ordinary (private-sector) French citizen to stand up and
protect his rights. The battle is far from over, but for the French and
for Europe as a whole, Raffarin must win. In fact, both Schroeder and
Raffarin must win if British public opinion is ever going to warm towards
the euro. |
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Recommended average maturity for bonds in each currency
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Stay long in dollars and euros, yields have to decline further.
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Currency: |
USD
|
GBP
|
EUR
|
CHF
|
As of
07.05.03 |
2013
|
2008
|
2013
|
2008
|
|
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Basically, nothing has changed. Equity markets continue to be well
supported, and profit taking in the bond markets shows that more and more
frustrated people are looking for an entry opportunity to buy stocks.
Recent economic releases out of the US remain mixed, but above market
expectations, and may lead to a cut of only 0.25rate by the FED on 25th
June. The forex market continues its sideways trading pattern, with
EUR/USD 1.1650 to 1.1950 as the most probable range, and exaggerations
possible between 1.13 to 1.2200 over the next couple of months.
|
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EUR/USD: Levels of 1.1900 and above
remain very short-lived, and attract some profit taking on longs. Support
comes in at 1.1720, more important at 1.1650 and crucial 1.1550. Breakout
on the topside is at 1.1950 |
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USD/CHF: Levels below 1.3000 remain well
supported. Only a loss of 1.2880 would speak for further downward
pressure. Upside resistance is at 1.3170, followed by 1.3250. Breakout
1.3280 would lead to 1.3450. |
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USD/JPY: Same comment as before with the
BoJ successful in defending the USD/JPY 115.00 zone. 117.50/80 is still
acting as a major support zone, whereas 118.90/119.10 looks a bit heavy at
present. Only a clear break above 120.30 would trigger an additional move
in the direction of 121.50 |
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EUR/JPY: The consolidation range is
between 136.50 to 141.--, with levels above 140 causing some profit taking
on longs. Support is at 138.80, 138.30 and 137.50. |
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GBP/USD: Sterling remains king; all
resistance has been broken and our first target of 1.6750 reached, with a
high of 1.6900. A clear break above 1.7000 would open the door for the
next target of 1.7250. Support is at 1.6750 and 1.6630. |
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USD/CAD: We took profits at 1.3410 on
our long CAD position established at 1.3905 (495 pips), and await a
correction before re-establishing a long CAD position again. Strong
support is at around 1.33 to 1.3350. Resistance is at 1.3480, followed by
1.3610. |
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AUD/USD: Strong support is now at
0.6480. Topside resistance is at 0.6730, 0,6780 and 0.6850
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|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.3180
|
1.1780
|
1.5450
|
118.90
|
139.50
|
Current
spot level |
1.3130
|
1.1750
|
1.5425
|
118.40
|
139.15
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Support/Breakout |
1.3070
|
1.1650
|
1.5350
|
117.80
|
138.20
|
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AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.6780
|
0.5910
|
1.3480
|
1.7010
|
363.00
|
Current
spot level |
0.6710
|
0.5850
|
1.3405
|
1.6820
|
361.50
|
Support/Breakout |
0.6580
|
0.5750
|
1.3310
|
1.6750
|
355.00
|
|
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