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!).

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.

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.

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.

Recommended average maturity for bonds in each currency

Stay long in dollars and euros, yields have to decline further.

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

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.

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

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.

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.

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.

AUD/USD: Strong support is now at 0.6480. Topside resistance is at 0.6730, 0,6780 and 0.6850