Bond Outlook [by bridport & cie, April 24th 2002]

The scepticism we have expressed over many months about potential for growth in stock values, and our reservations as to the strength of any recovery in the USA, are gaining wider support. It may even be that, if such views become too much the received wisdom, we shall have to reconsider them! Seriously, however, we stick to our long-held view that beginning in 2000, and for what could well be most of the decade, the economy will characterised by lower returns wherever you look, even as inflation remains low. Investor satisfaction will be found with capital preservation and modest returns; returns of several tens of percent per year will be a fading memory.


Of course, the depressed mood of equity investors is partly a reaction to the realisation that the indebtedness of the telecom sector, both network operators and equipment makers, is a huge millstone for the sector and for the economy as a whole. Demand is bound to remain weak. 3G has gone off like a damp squib in Japan, which makes its chances of rapid take-off in Europe very slim. Spare capacity in fixed networks everywhere is so huge that demand for new equipment will remain low for a very long time. For equity optimists, good news can be teased out of earnings reports (Du Pont, PepsiCo, Gillette, by way of example), but, for the next few months at least, the GDP recovery will not cause much improvement in corporate earnings:

  • The Fed is steering a narrow course between controlling inflation and killing the incipient recovery
  • Corporations may seek growth in volume or growth in profits, because price control is more in the hands of customers than suppliers and cost cutting by more lay-offs cannot increase demand Price competition from Asia will ensure little room for price rises in the West.


The reason we see this poor return picture extending to the long term is the absence of correction to economic imbalances, a theme to which we return often ("ad nausea", some would say). One of the imbalances is the strength of the dollar. We have learnt long ago that "calling" a currency is a mug's game. That said, a number of signs are appearing that the dollar's super strength may be waning. We mention three:

  • Disillusion about US securities being a sure bet for increasing value
  • Serious doubts about the quality of financial reporting and investment recommendations (witness: eleven States have now joined New York in going after Merrill Lynch) An ineffective US foreign policy.


Nevertheless, the argument that there is "no alternative" to the dollar has some (declining) value. The euro zone countries remain unreformed, and so does Japan, despite the recent rise in share prices. (We cannot even find an irrational explanation for the Nikkei's recent climb, never mind a rational one!) For those, like us, who look for a silver lining in bad news there may be one in the Le Pen phenomenon and the dismissal of "Monsieur 35 heures" (we really feared Jospin would win): these events should make of Chirac a reformer for his swan song in French political life.


All these considerations are affecting our own clients. Those who are based in EUR and CHF are being cautious about dollar exposure and are lengthening the maturity of the euro component of their bond portfolio. Lengthening or bar-belling is looking more and more sensible as the yield curves on both sides of the Atlantic seem likely to flatten. Last week we thought only the dollar was ripe for bar-belling; this week we confirm it and make it our formal recommendation. For the euro a simple lengthening seems more in order, although obviously investors will be keeping a fair amount of their portfolio in cash.


Argentina is a country deserving everyone's sympathy. There is no "quick repair" solution. For investors, however, there is a serious lesson about seeking yield in sovereign bonds versus corporates. Both can turn sour, but corporates can spring nasty "overnight" surprises of which we have seen so many examples in recent months. Sovereign debt problems can be seen coming months in advance. On that subject, in strictly economic terms, Turkey is a source of concern, but the issue is not one of monitoring the economics but rather the politics: " how long Turkey will remain the Mid-East darling of the world's superpower?"


Recommended average maturity for bonds in each currency
Lengthen in euros, bar-bell in dollars, no change yet in Sterling and Swiss Francs.

As of 05.12.01
As of 30.01.02
As of 24.04.02
2005 but bar-bell

Dr. Roy Damary

Currencies (by GNI)


Neither the G7 meeting nor Mr.Powells peace mission brought fresh news to the financial markets. The situation in Argentina is worsening (banks are completely closed again till Thursday, resignation of the economic minister this week) and the IMF is not prepared to advance additional funds unless and until a pact on taxes is reached between the provinces and the Government. Watch out for a possible spill-over effect (Venezuela - Brazil etc).


The earning season is continuing to produce mixed results on both sides of the Atlantic and the foreign exchange markets remain trapped in well established bands, with a slight hope that the euro is finally going to show some strength. Mr.Greenspan's testimony before Congress clearly points in the direction that any expectations for an interest rate hike in June should be postponed till August, or even later (with the aim, of course, of generating a sustained economic recovery). In contrast, in Europe no wage agreement in Germany, strikes in Italy and the French elections are not inspiring confidence for a sustained recovery of the euro.


EUR/USD: The resistance at 0.8880 was finally broken to test slightly higher levels. A hold above 0.8840/60 is needed to generate further advances to 0.8950, 0.9010, followed by 0.9150. Any move above 0.9000 on a weekly basis might stimulate further euro bullishness, but which we think would not last for a long time. A weekly close below 0.8810/40 would immediately open the door for a retest of 0.8700 again.


USD/CHF: In this uncertain environment, it looks like the CHF is still attracting capital. The supports around 1,6430 are being seriously tested, and any sustained break would open the door for further CHF strength direction 1.6250. On the upside, two subsequent closes above 1.6650 would be needed to look for a reversal with targets of 1.6730, 1.6780 followed by 1.6850.


USD/JPY: Only a weekly close below 129.50 might provoke further JPY strength in the short run and open the door for 127.75 and 126.50. Upside resistance comes in at 130.50 131.30 and 132.50.


EUR/JPY: The major support zone remains around 114.50/80 and is holding for the time being. The upside capped by 116.50, 117.20 and 117.80. Any sustained break of 114.50 would see this cross immediately down to 113.00.


USD/CAD: We took profit on half of our short USD/CAD position (established at 1.5955) at 1.5678 (+277 points) and put a stop loss at 1.5830.


AUD/USD: The Aussie has continued to move gradually higher. Major support is now at 0.5280-0.5310 and a clear break above 0.5450 would open further Aussie strength direction 0.5510 as a next target.


GBP/CHF: 2.3850 remains the pivotal point. A clear break on either side would cause a movement of at least 150 to 200 points. No clear direction at present; volatile trading to continue.



Current spot level
Current spot level
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