Bond Outlook [by bridport & cie, August 22th 2001]

At our meeting this morning, we resolved to seek out positive environments where investment opportunities might arise amongst so much unremitting bad news. That is not such an easy task, but there are some rays of light. The following is the writer's own view. It is more "pro-European" than most of his colleagues', including our Chairman's.


The main source of optimism is Europe. Of course, Europe will need a US recovery for solid expansion to set in. Of course, the fiscal and structural reforms needed in Euroland are taking place terribly slowly. But the greater prudence of European economic management, which meant a lag on the USA during the boom, suggests less of a decline during the recession. We do not believe that the USA has yet bottomed out, since consumer spending and old economy corporate earnings have further downward adjustment to go through. The disenchantment of international investors with US investment opportunities has now given the chance to the dollar to find a more sensible level against the euro. This will help the USA, but a weaker dollar also means lower costs in euros for petroleum and many other goods and raw materials, giving a wonderful opportunity to Europe as the fear of inflation subsides and the door is opened for the ECB to lower rates. We would even hope that the European economies react more positively to lower rates than the American because private sector indebtedness is not so great (telecoms apart, but even that is not so bad as it was).


Then there is the arrival of the "euro in the pocket". We see this event, just four months away, as extremely positive for Europe. Intra-European trade must benefit from its psychological impact in reinforcing the single market. The sense European citizens have of being in one economy when they spend their money "next door" without changing it will be quite euphoric. In addition, the ability of members of the black and grey economy to hold euros as an alternative to dollars (and remember the Deutsche Mark has been taken away from them recently for fear of not being able to change it) should boost the euro further.


Finally there is the question of the UK joining the euro. The last UK election showed how unattractive to the voters an anti-European and anti-euro policy is. The opinion surveys show a general anti-Europe sentiment, but the election suggests no depth to that sentiment. If the Old Guard of the Tory Party vote in Duncan-Smith, the party can look forward to terminal decline. As the official Opposition, they will slow down entry into the EMU, but they will not stop it. If Clarke wins, the euro will be accepted that much faster. The UK within the euro zone should seriously improve the chances of those needed structural reforms. That country already does its best to keep the power of the functionaries of Brussels under control. It will fulfil this task (or duty!) even better inside the Monetary Union.


All this does not mean that European equity markets are about to rally. Equity investments look like needing the greatest prudence on both sides of the Atlantic for many months to come. Bonds, however, look good in two senses: first for their obvious defensiveness in equity bear markets, and second because carefully selected bonds now offer good returns at sensible risks. We might even go so far as recommending a new look at telecoms, now that a year has gone by since we recommended exiting this sector.


How does this comment fit in with our general preference for seeking yield among emerging markets rather than in corporates? First it has to be admitted that the unfolding crisis in Argentina is like a Sword of Damocles over most emerging markets, especially Latin American. Asian markets are also very vulnerable to the world economic slowdown. Where do we think an emerging market has good fundamentals and a degree of indifference to the rest of the world? Russia. From 900 bps spreads over dollar swaps earlier this year, spreads are hovering around 700 and a little over 500 in euros.


We slipped up last week in expecting the yen to fall faster than the dollar. Nevertheless, we not only believe the yen will resume its decline, but that a cheaper yen is absolutely needed by the Japanese economy as a route to inflation. One of the many economic lessons of recent years is that deflation is even more to be feared than inflation.


Despite his colleagues' complaints about this writer's endless barbs aimed at world leaders, there is one gentleman whom he believes to be heading for a fall: Paul O'Neill. How someone with such self-contradictory and controversial comments about the strength of the dollar and Argentina can seriously represent the US Treasury is beyond comprehension.


Recommended average maturity for bonds in each currency (changed 08 and 15.08).
Stay long.

As of 08.08.01
As of 15.08.01

Dr Roy Damary

Currencies (by GNI)


The FED opted yesterday to cut the Discount and the FED funds rate by a further 0.25%. They remain concerned by continued weak corporate profits, slower spending and weak growth abroad, while remaining optimistic on the housing sector.


The IMF has proposed another USD 8 billion for Argentina, but this still needs Board approval during September.


Market behaviour remains extremely negative on the dollar and the strategy right now is to sell the dollar on any rally.


In Japanese side, more and more capital flows back home are being detected in the context of the book closing end of September, as well as covering losses from a battered Nikkei. Repeated verbal intervention by monetary officials to weaken the YEN remains ineffective for the moment. Only a rapid move below USD/JPY 118.00 might provoke the BoJ to step into the market.


EUR/USD: The encouraging weekly close above the 0.9050 opens the door for further advances. The next hurdle to break is 0.9230, followed by 0.9280,0.9380 and 0.9450. Long-term support is now at 0.8880.


USD/CHF: After the 1.6500/30 area was tested a couple of times it finally broke. The next target is 1.6350 followed by 1.6180. The first resistance on the upside now is 1.6680, followed by 1.6750.


USD/JPY: As it was unable to close above 121.30, the yen is continuing is short-term appreciation. Only an intervention by the BOJ might save the US unit from testing its next target of 118.00 and with a weekly close below on the way to 115.00.


EUR/JPY: Consolidation continues in a 108.50 to 111.30 range. Despite the fact that we see a higher EUR/YJPY over time, we cannot exclude a short-term appreciation of the YEN.


USD/CAD: The CAD has weakened somewhat. We would use 1.5480 as a sell for half of a position, and open up the second leg at 1.5620 with a S/L at 1.5700.


AUD/USD: The break at 0.5280 puts the Aussie on a more friendly path. Next target on the upside is 0.5380 followed by 0.5550, while 0.5280 is acting as a major support now.


GBP/CHF: Consolidation in a 2.3750 to 2.4200 range. Next target 2.3500, while 2.4350 is acting as a tough resistance.

Actual spot level
Actual spot level
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