BRIDPORT INVESTOR SERVICES WEEKLY
 

Bond Outlook [by bridport & cie, June 25th 2003]

In early 2000 we wrote that the whole of the new decade would be one of low returns, and that investors would have to get used to levels well below what they had experienced in the 1990s. As this scenario unfolds, two new landmarks have been reached:

 

  • Acceptance of the situation by investors. This is making investors feel satisfied with their fixed-income portfolios. They are reducing their efforts to thrash around for better yield. Spreads across the board are very low for the risk implied in corporates or emerging market bonds and there has been the major correction we warned of these last two weeks. In addition, investors seem happy to take a punt on the stock markets despite the historical overvaluations in PE terms, as dividend yields are quite respectable
  • Official recognition by Central Banks and Governments that deflation has taken the place of inflation as the greater danger. This has put long-term yields on a solidly declining path, almost (but not quite) independently of stock market performance.

 

The public is learning to live with steady declining prices, and taking advantage of the low costs of borrowing. Of course, the American public moves much faster than the European (except, to some extent, the British) in remortgaging, and spending on credit. Whether that is an admirable characteristic or not depends on your view of deficit spending. Is the consumer heroically and responsibly keeping the economy going? Or is he irresponsibly living beyond his means with a long-term price to pay? Is the American the hare and the European the tortoise of Aesop's fable?

 

While we hold American economic policy in scorn, we have to admire the Administration for their persuasion skills. They are not only convincing the American investor and consumer that all is well, but are bringing on side such institutions as UBS, who are now singing exactly the script of the US Administration. "Never mind the deficits, never mind the indebtedness, forget the spare production capacity, do not worry about rising unemployment, all that low-cost money in consumers' pockets is bound to turn the economy round!"

 

Even if it were a good idea to put money in consumers' pockets at the price of a ballooning federal deficit, someone else will be taking it out again. Some weeks back we mentioned the growing deficit of the individual States. Unlike the Federal Government, the States are not allowed to run perpetual and growing deficits. They must cut services and/or increase state taxes. What the right hand gives, the left takes away!

 

All this discussion of "will the rate and tax cuts work or not" affects bond investors on a particularly difficult decision: stay long or take profits. The US Administration would have us simultaneously believe two mutually exclusive scenarios:

 

  • EITHER, the US economy recovers and deflation is defeated, causing inflation to return, interest rates to go up and leading to massive and sudden shortening of maturities. Judging the moment to jump will be very difficult, but once the move starts it will be massive.
  • OR, if the recovery is still off the radar screen, there is every reason to stay long in bonds with their locked-in cash flow and increasing prices (despite the bouncing of yields around between support and resistance, the secular trend is firmly down).

 

There may be an advantage of having a tortoise-like Euroland, but right now it looks like too much of a good thing! Nonetheless, with Trichet soon taking a driving seat and reforms in France and Germany struggling but still advancing, we may hope for a little hare-like injection of energy and responsiveness.

 

Elsewhere in the world, we notice the improvement of Uruguay's standing in the bond market. This is less a reflection of the country's own solidity than of Argentina's apparent economic recovery (echoes of Russia, post-1998). Bonds of both countries have move up from bottom, but resolution or Argentina's massive default is still a long way away.

 

Recommended average maturity for bonds in each currency

 

Stay long in dollars and euros. We choose the "OR" scenario above.


Currency:
USD
GBP
EUR
CHF
As of 07.05.03
2013
2008
2013
2008

Dr. Roy Damary


Currencies (by GNI)
 
Despite the quite nice recovery of the US unit, we do not think it yet possible to speak of a dollar turnaround and future strength. Huge profit taking on long euro positions against nearly everything has been seen. Tonight's Fed decision will be watched carefully, and more important than the size of the cut (0.25%, 0.50% or no cut at all), will be the message going with their decision. The mixed bag of contradictory economic data continues on both sides of the Atlantic and it is too early to assume a sustained economic recovery.
 

EUR/USD: All support levels were broken and 1.1450 nearly touched. We think that the best strategy is "buy on the dips" on further downside pressure on the euro. Support is at 1.1420, 1.1350 and 1.1280. Topside resistance is at 1.1550, 1.1620 and 1.1750.

 

USD/CHF: Resistance at 1.3280 was broken, but the rally is running out of steam around 1.3350. A weekly close above 1.3350 would open the door for 1.3450 and 1.3580. Support is at 1.3170, 1.3070 and 1.2970

 

USD/JPY: Same comment: a successful BoJ in its defence of the USD/JPY 115.00 zone. 117.50/80 is still acting as a major support zone, whereas 118.90/119.10 looks a bit heavy now. Only a clear break above 120.30 would trigger an additional move in the direction of 121.50

 

EUR/JPY: Here as well, all supports were broken and 135.-- almost reached. A weekly close below this would speak for a further down move, direction 134.20. Topside is 136.20 and 137.50.

 

GBP/USD: Sterling was blocked at 1.7000 only by the huge wave of profit taking on long euro positions. Downside support is at 1.6630 and1.6550, and key 1.6480. Upside resistance is at 1.6780, 1.6850 and 1.6930.

 

USD/CAD: Only a clear break on a weekly basis of 1.3300 would speak for further CAD strength. Resistance is at 1.3580, 1.3650 and 1.3720

 

AUD/USD: Strong support is now at 0.6480. Topside resistance is at 0.6730, 0.6780 and 0.6850

 

 

USD/CHF
EUR/USD
EUR/CHF
USD/JPY
EUR/JPY
Resistance/Breakout
1.3350
1.1580
1.5380
118.20
136.20
Current spot level
1.3280
1.1540
1.5320
117.60
135.50
Support/Breakout
1.3170
1.1450
1.5280
117.20
134.80

 

AUD/USD
NZD/USD
USD/CAD
GBP/USD
XAU/USD
Resistance/Breakout
0.6730
0.5910
1.3580
1.6850
355.00
Current spot level
0.6680
0.5850
1.3530
1.6710
348.50
Support/Breakout
0.6580
0.5750
1.3480
1.6650
343.00
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