Bond Outlook [by bridport & cie, January 23th 2002]

The Enron saga is about far more than the misdoings of one company and its auditor. It is about faith in the American system of providing reliable and truthful data to investors. All the bedrocks of incorruptibility --auditors, investment banks, advisers on fiscal law --look a lot less reliable. Adam Smith's historic view about the temptation to collude, to which the business community is continually prone, has returned two and quarter centuries after he wrote it (1776). Faith that the free-market economy is self-correcting (because every one wants every one else to be honest, and transparency of data ensure visibility) was all the rage in books on business ethics written in the early 1990s. That faith is seriously wavering and under threat because transparency has given way to opacity, applying the spirit of the law to fulfilling its letter, e.g. "off balance sheet is out of mind and out of sight". The events in the USA will give a great boost to IAS (International Accounting Standards) over GAAP (Generally Accepted Accounting Principles). IAS will become obligatory in the EU in 2005 and is being adopted by many other countries. Just possibly GAAP could also accept the principle of auditors "following up" on all matters of relevance, but the US audit profession has proven very resistant to such a change, time and time again, which is partly why the founders of IAS have moved ahead without the USA.


The undeniable economic success of the USA has led to blindness to any weakness in the system. The pro-business government stance, freedom of commerce, lightness of labour laws, moderation in social charges, the positive attitude to wealth creation - they are all wonderful features of the USA. However, when the custodians of transparency deceive and deny that they are deceiving, then it is legitimate to demand changes. Fortunately, the US people and press will act where politicians have totally failed.


Many other denials are to be found over the USA. In earlier weeklies we have called them the "need for rebalancing". They include consumers spending beyond their means, share valuations based on future profit growth levels never yet seen in history, and a dollar too strong to reduce an external current account deficit of 6.2% of the GDP.


Part of the strength of the dollar is the lack of a viable alternative. A feeble yen is "accepted" policy in the USA and Japan, despite Chinese protests, and likely competitive devaluations throughout Asia later this year. We have always believed a weaker yen will help bring inflation, a much needed "evil" to encourage Japanese consumer spending. Yet, alone, inflation cannot solve the problem, and even brings new dangers with it. The greatest of these is that Japanese investors will see 135 yen to the dollar as a guaranteed dollar floor, so they will have every interest in seeking better returns on non-Japanese bonds. The credit risk on JGBs is increasing anyway, thus there is every chance that yields will rise, and the fall in the yen continue. All to the good if money in Japan finally achieves a positive time value, but, for the banks, very costly. Not for nothing have their ratings been watch-listed negative yet again this week.


The euro should, of course, be a valid alternative to the dollar. The strengthening we expected to see in 2002 has still not begun and may have been an illusion. Our confidence that black marketeers and third country reserve banks would buy euros and push up the value is being seriously undermined by the likely joining of weaker economies in the East and South. Moreover, it is really hard to associate a strong currency with government policy, led by the French, to legislate against work. Forthcoming elections in France and Germany could reverse the trend to non-competitiveness, but we would not hold our breath!


Opacity of accounting is not a purely US phenomenon. Look at German banks, in particular, DePfa, the public sector and property bank, which is now separating the operations and names of its two main activities. Will Aareal Bank AG, the new name for the property bank, be more forthright on the quality of the 2/3rds of its loan portfolio devoted to commercial properties and much more vulnerable than retail mortgages? If you are suspicious by nature, you would note that the DePfa Group reports according to GAAP, not IAS, while the sister (public financing bank) has been established in the tax/haven of Dublin.


On the emerging market front, the spread movements cannot yet be interpreted as a particular trend. For the strong-hearted, there could be interest in Argentinean Brady "Pars" which offer significantly greater value than the Eurobonds. Feel free to call us to run through the arithmetic.


Kmart has gone into Chapter 11, and it will be hard to imagine a turnaround when suppliers have pulled the plug. At the other end of the retail spectrum, Saks is not at all happy about its downgrading. US consumers are still spending, but they seem reluctant to grant the retailers much profit!


Recommended average maturity for bonds in each currency
While we are not changing our average maturities, the bias is towards further shortening.

Over the period 15.08.01 to 21.11.01
As of 05.12.01

Dr. Roy Damary

Currencies (by GNI)


The JPY continues to be in the spotlight of the foreign exchange markets with the visit of US monetary officials meeting their counterparts in Tokyo. They are discussing monetary policy, the weak economic environment and the weakening yen. After meeting US manufactures the week before, Mr O'Neill, US Treasury Secretary, commented only that it was up the market to decide the appropriate level of the yen, and that the USA was still interested in a strong dollar. The overall trend for the year will be substantial yen weakness. The clean-up process inside Japanese banks is still underway, but contains the potential for many on w nasty surprises. A loss of confidence in the JGB market would be catastrophic, not only for Japan but also for the international financial system.


EUR/USD: A quick test below 0.8800 was short lived. Support comes in at 0.8750 and breakout level on the topside is at 0.9010. Short term, we see some consolidation in this trading range.


USD/CHF: Again the US unit tested a high of 1.6730, with the big breakout level on a weekly basis at 1.6780, followed by 1.6900. Support comes in at 1.6500, followed by 1.6380.


USD/JPY: The corrective move on the downside has been short and quick. 133.00 was successfully broken on the way to our first price objective at 136.90. Support is 131.80and 130.50 and resistance at 135.50,136.90 followed by 140.00


EUR/JPY: Consolidation in a 115.50 to 119.50 range. Medium term, we are looking for higher levels in the direction of 125.-


USD/CAD: We keep our short position USD/CAD at 1.5955 with a S/L at 1.6300. Price objective is around 1.5650.


AUD/USD: The Aussie has created a solid base above 0.5000 but needs to break 0.5280 on a weekly basis to make further progress, direction 0.5400.


GBP/CHF: Extreme volatility will remain in this cross. 2.3850 is acting as a pivot point, with a weekly close above looking for 2.4100 or below for 2.3550.



Current spot level
Current spot level
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