Bond Outlook
[by bridport & cie, November 21st 2001]
Immediately after the September 11 attacks we were looking for some
silver linings in the clouds, and we found hope that relations between the
West and Russia (and Iran) would improve, and that many of the processes
already underway to correct the post dot.com bubble would be accelerated.
These things have come to pass, more quickly that we expected, and with
some big bonuses. The "new" Russian connection is of key strategic
importance, resulting in the taming of OPEC's power to squeeze the world
every time its economy looks like doing well. The USA now feels able to
push seriously and even dictate the Palestinian/Israeli "peace process" in
the direction of a Palestinian State, with Israel withdrawing from the
Occupied Territories (it will be interesting to see if Colin Powell and
the UN dare use that appellation). The USA has cut its rates even faster
than it otherwise could have, flooding the money supply while disinflation
reigns. The liquidity and general "feel good" factors, such as the Taleban
disintegrating, have led to a major recovery of the stock markets. Bonds
have fallen in value, giving back between a quarter and a third of their
gains since August 15, when we recommended lengthening. |
|
To some extent fixed-income specialists are bound to be somewhat
sceptical about stock markets, so readers will bear with us while we spell
out our reasons for caution about the current bull stock
market: |
|
- The hard data on
industrial production and employment are still moving down
- Company earnings
are still declining (and that includes forecasts for the current
period)
- Corporations
still have a long way to work through their excess inventories
and over-capacity
- Consumer spending
in October was so high only because of special car financing
deals
- The US GDP growth
of 4.2% in 1999 has fallen to 1.1% in 2001 and is forecast to fall
still further to 0.7% for 2002 (source www.economy.com)
|
|
Can profits grow when underlying GDP growth is so anaemic? Can
these PE ratios be sustained? PEs are now back at levels (almost 30 on the
DJIA) last seen when we doubters were all thinking the bubble had to
burst. One view is that such PE levels can only be justified if earnings
turn round and move forward. Another is that PEs have become less relevant
(as they were for so long during Japan's long bubble). So much money,
loath to accept the low yields of fixed-income instruments, prefers to
seek potential for further rises in stock values. |
|
While stock markets are undeniably bullish, bond markets are
telling a mixed story. Admittedly, Treasuries have declined, while
corporate bonds issues, especially convertibles, are highly sought after,
with a lot of issuance. Yet, at the other end of the scale, in speculative
grade bonds, default rates are approaching those of 91/92. Furthermore,
the ratings agencies are downgrading far more corporate bonds than they
are upgrading. Such direct contradictions of the corporate bond market and
the equity market last occurred in 1991, when it turned out that bond
pessimists were right. |
|
While satisfied with getting the stock market on its feet, the Fed
will still be looking for traction in the real economy. Since this has not
yet been achieved, further cuts down to our expected low of 1.5% in the
overnight target rate are almost certainly in the pipeline. Similar cuts
may be expected in Europe, although rates will stay significantly higher
in absolute terms than in the USA. |
|
As the USA steers between the dangers of inflation from
success of its economic policy and deflation from failure, we
remain optimistic that success will be achieved, but not so quickly as
most commentators are supposing (we see underlying recovery a year away,
not a mere six months). |
|
As we have indicated in our recent weekly comments, some of our
clients have already been shortening. The time has indeed come for a
general move from long to medium maturities. We are putting all major
currencies at five years (which implies the greatest shortening for euros
and Swiss Francs). Actually, this is not yet the drastic and rapid
shortening that we may still have to recommend if traction is achieved.
Rather it is an adjustment to reflect the changing shape of the yield
curve. |
|
Recommended average maturity for bonds in each
currency Begin to shorten, especially in
euros. |
Currency: |
USD |
GBP |
EUR |
CHF |
Over the period
15.08.01 to 21.11.01 |
2008 |
2006 |
2011 |
2011 |
As of
21.11.01 |
2006 |
2006 |
2006 |
2006 |
|
|
No major volumes are to be found this short, Thanksgiving week. In
the USA profit taking on stocks already started yesterday, and it will be
seen what happens before the long weekend. This morning the Ifo October
business climate showed that the ECB may be expected to cut interest rate
by another half point. Also the BoE November minutes came out in line with
expectations and showed strong endorsement of the last rate cut on the
8th November. |
|
EUR/USD: The single currency is moving
in a broad range 0.8760/0.8890. With the strong recovery of the US stock
markets the last two weeks, pressure has continued to push down the euro.
For the week to come, we favour a test and a break of the bottom of the
fork, with a first objective at 0.8710. Only a break of 0.8950 on the
upside could oppose our bearish view. |
|
USD/CHF: We are targeting 1.6770
medium term, followed by 1.6850. 1.6470 supports the greenback and an
exaggeration up to 1.6350 is possible. On the upside, 1.6635 could slow
down any change in the exchange rate. |
|
USD/JPY: Tried twice to break 123.50
without success. Now the exchange rate should find support at 121.50 and
once again try the break on the upside, which should open 124.25 and
125.30. |
|
GBP/USD: A quiet, impressive move over
the last two weeks. Sterling has now found support between 1.4115 and
1.4080. A correction in the direction of 1.4350 should appear. A break of
1.4080 should announce 1.3975. |
|
EUR/JPY: Triangle formation. A clear
break of 109.30 or 106.80 should show the next significant
move. |
|
USD/CAD: Keep the position short USD
long CAD. Trading range 1.6050/1.5800. We are expecting a break of 1.5800,
to target 1.5600 medium term. |
|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.6850 |
0.8950 |
1.4750 |
125.30 |
109.50 |
Current spot
level |
1.6560 |
0.8790 |
1.4660 |
122.85 |
108.10 |
Support/Breakout |
1.6350 |
0.8710 |
1.4500 |
121.50 |
106.75 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5280 |
0.4280 |
1.6050 |
1.4350 |
277.50 |
Current spot
level |
0.5175 |
0.4130 |
1.5995 |
1.4205 |
273.00 |
Support/Breakout |
0.5010 |
0.4080 |
1.5800 |
1.3975 |
270.00 |
|