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 2½ 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%? |
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To drive home the severity of the problem, consider the imbalances
in urgent need of redressing: |
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- 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.
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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? |
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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! |
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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! |
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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.
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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! |
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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 |
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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. |
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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. |
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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. |
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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. |
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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. |
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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. |
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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. |
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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 |
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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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