Financial markets are always full of contradictions, but that is what makes markets. Nevertheless, the current contradictions are particularly extreme:

• Share values are generally headed higher despite corporate earnings going down.
• There is expectation of a strong US economic rebound, yet corporations are continuing to lay off employees.
• Investors are putting money into equities, thus strengthening the share market, even while the flight to quality continues in the bond market.
• There are so many new issues of corporate bonds, including convertibles, that T-bond prices are being held back, and yet spreads on existing corporate bonds are still widening.

To make sense of all this is already extremely difficult, as is the distinction between terrorist effects and what was happening anyway. Certainly there is room for scepticism over stock valuations and the timing and strength of recovery. It is hard even to think in terms of a "rebound", be it in stock prices or fundamentals, while correcting the imbalances of the US economy (like an improved savings rate and reducing the trade deficit) has hardly started. "No one wants to miss the major rally", it is said, so the huge amount of cash looking for a home is pushing the market up. Many believe "the major rally" to be figment of the imagination. Where can a market rally to when its PEs are already 24 (DJIA) to 29.5 (S&P 500) and earnings forecasts still pointed downwards? If it does rally, it will take an awfully major future drop to bring earnings yields back to anything like an appropriate level for equity risk. Unless, of course, earnings catch up quite remarkably, the likelihood of which seems small over the next few months.

In a period of so much uncertainty, investors are seeking a degree of protection, while not wishing to lose out if and when stock prices increase. This helps understand the principle of mixing top quality government and stocks. As for the large supply of corporate bonds, which are having to be issued at increasingly higher spreads, investors are finding the absolute level of interest rate attractive. Likewise, convertibles remain attractive to the issuers because the interest cost is lower than for straight bonds, while the investor is prepared to accept a low yield for the chance of participating in a possible stock rally yet with a price floor.

Even when prices decline, every security finds its equilibrium price (unless, of course, bankruptcy ensues), so fixed income investors must be asking themselves whether default by more large corporate issuers is possible. Our expectation is that corporate bond spreads are more likely to widen further in the immediate future than to narrow.

Emerging markets sovereign bonds remain well bid. Argentine has stabilised at some 20% over US Treasuries. Turkey is issuing new debt, and better credits such as Russia or Mexico are tightening further.

Last week we said that US government financing was moving into deficit this fiscal year. Specific data may now be attached to this affirmation. In August, fiscal 2002 was forecast to have a surplus of USD 165 billion, a figure now changed to USD 50 billion deficit. The proposed USD 75 billion additional tax relief is on top of this. In the first part of the year profits on bonds were made at the short end of the yield curve, which is where we recommended institutional investors to be till mid-August. Since then, the yield curve has moved down also at ten years (which corresponds to our concept of long), making a long position attractive because of the leverage effect. Now the question remains of when all those new US Government and corporate bonds push up rates at the long end. "Not yet" is our answer, but we have to keep watching. Our bond message remains unchanged: remain long, keep quality and be ready to jump short.

In recent weeks we have been moderately optimistic about Europe. We must now admit to losing faith, except for the UK, which seems to be surprising even British politicians. In the euro zone, however, the combination of a recalcitrant ECB and the Stability Pact preventing fiscal deficits is proving negative both in market perception and fundamentals. It is so frustrating to think that the euro zone might have proven itself able to weather downturns better than the USA. We still cling to the hope that the arrival of euros as a real currency will be a positive event for the economy and the single currency itself.

In Japan's desire to lower the yen exchange rate, purchasing T-bonds is part of the solution in helping the US keep long-term interest rate down, but part of the problem (in our eyes) in pushing the dollar back up.

Recommended average maturity for bonds in each currency
No change yet.

The stabilisation of US equity markets with mixed earning results (the poor ones are being ignored), positive talk by officials, the Fed being praised for its guiding an aggressive monetary policy and the US government for quickly stimulating the economy, have all added up to the market already painting a rosy picture for a US recovery. In contrast Euroland does not produce any encouraging news (IFO lowest since 93), and the ECB is not proactive. The market is expecting at least the gesture of a quarter point cut this Thursday. No action will put the euro under additional selling pressure.

EUR/USD:Once again, a major disappointment with the break at 0.9000. Next supports are at 0.8830 followed by 0.8790 with objective at 0.8650. Only a quick recovery above 0.8960 with a weekly close above 0.9000 would take off the pressure of the euro.

USD/CHF: Recent recovery in the equity markets, huge S/L buying and major appetite for US bond issues caused an easy break of the key resistance at 1.6510/30. Next targets are 1.6680, 1.6750 followed by 1.6880. Only a weekly close below 1.6500, or major turmoil created by new anthrax cases, would put the greenback under pressure again.

USD/JPY: With a solid base around 120.-in place, levels near 123.00 has been tested. A weekly close above 123.10 would open the door for 124.80. We continue to favour some range trading in a 121.50 to 123.00 range in the short term.

EUR/JPY: A large consolidation range of 107.-to 112.00 prevails with the BoJ protecting the downside.

USD/CAD: After the cut by BoC of 0.75 %, a large consolidation range is prevailing in a 1.5450 to 1.5780 range.

AUD/USD: The bottom of the Aussie has managed again to move above 0.5000. The range lies in a 0.5010 to 0.5180 range.

GBP/CHF: Extreme volatility will remain in this cross and only a clear break of the resistance at 2.3850 will open the door for its next target at 2.4100. Major support comes in 2.3550, followed by 2.3300.