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. |
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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). |
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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. |
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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. |
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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. |
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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. |
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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. |
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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. |
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Recommended average maturity for bonds in each currency
(changed 08 and 15.08). Stay
long. |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
08.08.01 |
2006 |
2006 |
2007 |
2010 |
As of
15.08.01 |
2008 |
2006 |
2011 |
2010 |
|
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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. |
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The IMF has proposed another USD 8 billion for Argentina, but this
still needs Board approval during September. |
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Market behaviour remains extremely negative on the dollar and the
strategy right now is to sell the dollar on any rally. |
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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. |
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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. |
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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. |
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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. |
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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.
|
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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. |
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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. |
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GBP/CHF: Consolidation in a 2.3750 to
2.4200 range. Next target 2.3500, while 2.4350 is acting as a tough
resistance. |
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USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.6680 |
0.9280 |
1.5250 |
121.30 |
111.00 |
Actual spot
level |
1.6480 |
0.9220 |
1.5195 |
119.65 |
110.25 |
Support/Breakout |
1.6450 |
0.8880 |
1.5050 |
118.00 |
108.50 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5480 |
0.4510 |
1.5550 |
1.4650 |
283.00 |
Actual spot
level |
0.5380 |
0.4445 |
1.5480 |
1.4570 |
277.60 |
Support/Breakout |
0.5050 |
0.4330 |
1.5350 |
1.4380 |
268.00 |
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