The passage of Wal-Mart to become the largest company in the world by sales is a sign of the times; US consumers keep spending and increasing their debt, despite the recession, but much prefer discounters over conventional retailers. The USA is attempting to sail through a recession by borrowing at every level:

• Consumers, whose ratio of consumer credit to disposable income has oscillated since 1970 between 13% and 17%, is now about to break through the 19% level
• Corporations, whose ratio of debt to profits, historically between 3 and 4 times, has risen to 6
• Government: increased military spending and tax cuts have turned the surplus into deficit (its size is still unclear, but in the order of 1% of GDP, quite modest so far)
• External current account: now at 4.8% of GDP and heading next year to 6% (massive adjustments are reckoned to occur at about 5%).

In other words, the USA is living above its means and on debt, and the rest of the world is living on the USA. Nothing has been done to adjust the great imbalances of the American economy, an approach we likened over a year ago to sending a flu' victim on his way without any attempt at cure or rest. Not a healthy approach!

The sense of the unreal, of which "Enronitis" is a symptom rather than the prime cause, is now affecting financial markets. Confidence in a great rebound in equities this year is still present, but much diminished since the beginning of the year. Led by UK pension funds, a major shift from equities to bonds is under way (Boots the Chemist was the pioneer last year). In a sense, this is but a return to normal for pension funding; it was the 1990s with their overvalued stock values that were the exception. It all boils down to an expression we used for the conclusion we spelt out last week, that this is a time to give preference to capital protection, over returns.

As if the US economic situation were not enough to justify this conclusion, there are two other massive threats hanging over the world economy (leaving aside issues of terrorism, Axis of Evil and the Mideast):

• The first is Japan, which differs from the USA in knowing that its economy is in trouble, but shares with the USA its propensity to do nothing to resolve outstanding issues. Deflation remains and unemployment keeps moving up (now 5.5%). The ratio of public debt to GDP, at 130% last year, is rising to 140% in 2002. The "mark to market" event of end March will eject more skeletons from the cupboards. The slow motion collapse of Japan is ripening for a speed up
• The second is pension funding in almost all the developed world. Except for Switzerland, the UK and the Netherlands, government "pay as you go" schemes are totally under-funded and will mean the working population supporting ever more retirees. Governments will be politically unable to impose the tax increases necessary to close the gap, so they will borrow. All will go the way of Japan. Another case of denial by politicians.

These three (US rebalancing, Japanese reform, pension refinancing) are the big examples of political leadership failing to act now, putting off the inevitable to a very evil day. Currently there is a fourth example, reform in the euro zone to a more pro-business environment, but, important though this is, it pales in significance compared to the "big three".

The dollar's immediate strength is mainly tied to Japan. In this first quarter of 2002, the Japanese are repatriating funds to deal with the March 31 deadline. Thereafter two opposing routes are open: they may recall their overseas assets to deal with their crisis at home, or they may so lose faith in their own economy and switch all those domestic savings to foreign assets. The former seems the more likely to us.

The brightest spot in the world economy at present seems to be Asia ex-Japan, where forecasts of economic growth are high if Japan does not collapse and still positive if it does. Bond spreads in these countries are nevertheless likely to widen as Japan worsens, so it is a little soon to see them as a buying opportunity.

Argentina has forced conversion of provincial bonds from dollars to pesos at 1.40. Our conclusion is that the bottom on foreign debt has not yet been reached.

Recommended average maturity for bonds in each currency
We stay our hand on bar-belling, which we see as the next step. Stay short, including FRNs.

In the US, the accounting trauma is still hurting people's confidence in the potential recovery of the US economy. The stock market is waiting for the end of March to see the impact of the reduction of the inventories and equity investors are hoping for a rebound at that time. In the very short term, the mood is still bearish and affecting the whole financial industry.

Japan remains under water and we do not see what can take it out in the short term. We shall have to wait for Japanese yearend on March 31st for a fresh evaluation of the Japanese economy. We expect the yen to weaken further after that date. In Europe, the stock markets are seeing no rebound and the appetite for stocks, expected from fresh money going into pension funds, remains very weak.

EUR/USD: A broad trading band of 0.8500 to 0.9030 is still valid. Key support is at 0.8480 and key resistance at 0.9030, with pivotal point at 0.8750. We still favour fresh selling of the euro in the 0.8850 to 08950 area.

USD/CHF: So long as the exchange rate stays above 1.6750/80, the dollar remains in a range with a key resistance level of 1.7250. Only a weekly close below 1.6750 would put the bullish outlook into doubt and point to a deeper correction, down to 1.6550 first.

USD/JPY: The yen remains in its range of 131.50 to 135.30 for the time being. We still favour a continual weakening of the yen, with our first target of 136.90, followed by 140.

EUR/JPY: We keep our wait and see stance. We would reopen 50% of a long EUR/JPY position below 115.00. Consolidation in a 114 to 118 trading range is expected.

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

AUD/USD: The Aussie remains under pressure. A move below the psychological barrier of 0.5000 would be catastrophic and erase the Aussie potential to appreciate in the short term. A clear breakout of 0.5350 would be needed to sustain a rally towards 0.5500.

GBP/CHF: Extremely volatile at the moment with no clear trend. It remains in its broad range of 2.3850 to 2.4450. This range will stay in place unless the USD starts to trend lower.