BRIDPORT INVESTOR SERVICES WEEKLY
 

Bond Outlook [by bridport & cie, November 20th 2002]

Reality denial is alive and well in the USA, with Alan Greenspan singing in harmony with the whole Administration. "How well", boasts he, "we have done to have no major financial institution collapse during this difficult period". Thus may it long continue. What cannot continue is the wishful thinking that by cutting interest rates, the economy, with the stock market, will again take off. In early 2000, we said that the recovery could not be achieved by interest-rate cuts alone, but only by rebalancing the US economy - and that takes belt tightening and time. Our view has never wavered from this, but we have had to wait 2 years before commentators are broadly adopting this position. How much longer before the Administration recognises it? Dare we suggest about six months, when it finally sinks in that the cut to 1.25% is no more effective than the earlier cut to 1.75%?

 

To drive home the severity of the problem, consider the imbalances in urgent need of redressing:

 

  • The external current deficit at 5% of GDP and worsening (a year ago, as 5% was approaching, many commentators were saying that is the threshold of unsustainability)
  • The internal deficit at 1% of GDP and growing
  • Industrial capacity utilisation is stuck at the low level of 76%
  • Corporations, States, cities, households, pension funds are all over-indebted
  • Stocks are currently valued at almost double their historical basis in terms of PE.

 

Add to this a wavering of consumer spending (not a bad thing - its maintenance by false promises of a recovery has only delayed the inevitable), the mistrust of the financial and corporate world, and the growing economic power of China, especially relevant for its trade surplus with the USA and the downward pressure on prices and profits. Consider also the real impact of the Internet revolution: a massive shift in knowledge and negotiating power from suppliers to buyers of any good or service, an opening up of competition and the loss of sustainable competitive advantage. Do you still believe in an imminent economic recovery?

 

Unfortunately it is not only the USA that is in trouble. Japan can be held up only as the example of what the USA seems to be heading for. The macroeconomic incompetence of Euroland is breathless. China, despite its GDP growth and exports, already has deflation plus a developing banking crisis. Even the UK has its housing bubble waiting to go pop. Well, Canada, Australia and New Zealand do not look too bad, but, overall, the world is in a mess! The other thing we said in early 2000 was that the coming decade would be one of low profits, returns and inflation and that asset protection would be more important than seeking returns. Would that we had trumpeted it louder!

 

What will happen next? Greenspan will finally accept that the economy no longer responds to cheap short-term money. He will study once again the way the USA finally worked its way out of the 1930's depression, and he will have to play the card of ever increasing liquidity, not by lowering short-term rates (negligible room left) but by buying outstanding long T-Bonds, thus flattening the yield curve. This is monetisation of Government debt. It can also be called "printing money". Greenspan will hate doing it, but will have no alternative. He can take comfort that in the 1930's, no hyperinflation occurred in the USA, although he must be aware of what happened in the Weimar Republic!

 

In terms of strict economic fundamentals, a flattening yield curve suggests long maturities for bond portfolios. Our current recommendation is only "medium". This reflects our acknowledgement of the peculiar circumstances of the year-end, the need to book profits on bonds and the temptation to participate in the supposed bear-market stock rally. The ECB will probably lower rates at its next meeting, but a 50 bp cut is already priced in for bonds. By all logic, the dollar should weaken further and eventually help rebalance US international trade. The euro will therefore strengthen, but not thanks to Euroland's economic policies.

 

Let us finish on a nice quote from French economy minister Francis Mer: "It is critical that we realise that we cannot continue to act collectively in increasing, year after year, the indebtedness that we leave to our children." May his countrymen and just about everyone else take heed!

 

 

Recommended average maturity for bonds in each currency.
See the five-year average as a trading opportunity.


Currency:
USD
GBP
EUR
CHF
As of 10.07.02
2012
2007
2012
2012
As of 06.11.02
2007
2007
2007
2007

Dr. Roy Damary



Currencies (by GNI)

 

For the second week in a row, the euro is still holding above parity, despite worsening numbers out of Germany (a black hole of over € 30 billion in tax income for 2002/3 and the announcement of a new capital gains tax of 15%). In addition, official EU warnings about the Government deficit is very inconvenient at this stage for the weak Schroeder coalition and for Europe's erstwhile economic powerhouse. More and more voices are playing down inflationary pressures, even from ECB members. This suggests that the ECB must finally give way and cut rates, probably in early December. It looks to us that market participants are searching for yield (NZD, AUD, CAD), and we have the impression that this euro rally will soon be running out of steam.

 

EUR/USD: The euro looks toppish in the 1.0130/50 area, and only a clear break of 1.0175 would speak for further euro gains. The downside looks vulnerable, and a close below parity would target first support at 0.9950 and 0.9880. A drop below 0.9850 would be catastrophic and open the door for 0.9700 at least.

 

USD/CHF: The US unit looks very well supported below 1.4500. As long as the rate stays above 1.4550, further recovery looks like the most probable outcome. The next hurdle is 1.4680, then 1.4750 followed by 1.4850. Support is coming in at 1.4450, 1.4380 and 1.4330. A drop below this last level would speak for a substantially lower dollar.

 

USD/JPY: We still believe that the BoJ will defend the dollar between 118.00 and 120.00. Major support is at 120.50. Topside resistance is 122.80, 123.10 and 123.80, followed by 124.50.

 

EUR/JPY: The trend clearly remains towards the upside. 122.50 has been broken and 123.00 tested so far. The next levels are 123.30 and 123.80. A weekly close below 122.30 would mean entering once again the old trading range of 120.50 to 122.50.

 

USD/CAD: The 1.6000 zone has nearly been reached again. This is an excellent level to buy some CAD. Support is at 1.5810 and 1.5760, followed by 1.5650.

 

AUD/USD: So long as 0.5570 is held, the upside objectives are 0.5630 and 0.5680, followed by 0.5750. Major support is at 0.5480.

 


 

USD/CHF
EUR/USD
EUR/CHF
USD/JPY
EUR/JPY
Resistance/Breakout
1.4680
1.0150
1.4730
123.10
123.10
Current spot level
1.4660
1.0005
1.4675
122.65
122.70
Support/Breakout
1.4580
0.9950
1.4640
121.50
122.30
 
AUD/USD
NZD/USD
USD/CAD
GBP/USD
XAU/USD
Resistance/Breakout
0.5650
0.4980
1.5880
1.5810
324.50
Current spot level
0.5590
0.4960
1.5835
1.5735
319.50
Support/Breakout
0.5575
0.4930
1.5730
1.5820
318.00

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