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: |
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- 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.
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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?
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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!" |
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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! |
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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: |
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- 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).
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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. |
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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.
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Recommended average maturity for bonds in each currency
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Stay long in dollars and euros. We choose the "OR" scenario above.
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Currency: |
USD
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GBP
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EUR
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CHF
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As of
07.05.03 |
2013
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2008
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2013
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2008
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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. |
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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.
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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 |
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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 |
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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.
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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. |
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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 |
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AUD/USD: Strong support is now at
0.6480. Topside resistance is at 0.6730, 0.6780 and 0.6850
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USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.3350
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1.1580
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1.5380
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118.20
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136.20
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Current
spot level |
1.3280
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1.1540
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1.5320
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117.60
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135.50
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Support/Breakout |
1.3170
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1.1450
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1.5280
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117.20
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134.80
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AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.6730
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0.5910
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1.3580
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1.6850
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355.00
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Current
spot level |
0.6680
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0.5850
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1.3530
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1.6710
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348.50
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Support/Breakout |
0.6580
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0.5750
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1.3480
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1.6650
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343.00
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