There is something rather distasteful about equity markets and the dollar bouncing up and down as a function of battlefield news and hype. It certainly makes it difficult for us to keep our focus on fundamentals and secular trends while war excitement reigns. All the more reason, then, to persist.

All the economic news out of the USA is negative, but tinged with unreality, almost as if patriotism is overriding good sense:

• The $ 400 billion federal deficit is widening to $ 500 billion because of the war (numbers almost identical to the external current deficit), yet the Administration is seeking tax cuts (now sensibly reduced by the Senate)
• Consumer confidence is at the lowest levels since October 1993, yet consumer spending and house purchasing just keep on expanding
• Investor optimism reached a new low this month, but equity markets rally.

"But it's all only make believe!" (Roy Orbison's song as national anthem?). Or, as the FT succinctly puts it: "In Mr Bush's dream world, you can fight an enemy and hand out tax relief at the same time."

Many asking questions at this time about whither the world in the light of the breakdown of multi-lateral decision-making. Our question is of a more economic nature: whither the world when its superpower has overspent? An argument we first expressed three years ago is gaining strength: a country, even a superpower, which depends on the rest of the world buying its assets at a rate of $ 400 billion (now $500 billion) per year, cannot maintain a strong currency if (or rather "as") its assets become less attractive. Moreover, the situation is inherently unstable. Attractiveness is first measured as rates of return, already very low for US assets, but worsens if it is suspected that the currency of those assets has still further to fall. From the end of World War II to the early 1980s, with a brief exception in 1973/4 when it looked like the OPEC countries would buy up the world, the USA net asset balance (what it owns minus what it owes) was 5-8% of its GDP. Europeans feared that their industries would be entirely owned by Americans. The balance is now minus 20%, and worsening at nearly 4% per year (source: Bridgewater).

A weaker dollar will eventually lead to inflation, but the deflationary forces in the USA are still very strong. A stronger euro, the inevitable flipside of a weaker dollar, cannot help the European economies, unless Europe itself can provide a demand motor. We hold on to that hope like a drowning man to a straw. We look for signs, e.g. for a move to an external deficit, now easily supportable. Then, can the Germans reform their costly welfare system? Schroeder's announced policy looks encouraging (it must be, as the unions are screaming!), but can he deliver? If yes, his country and his chancellorship could be saved. If no, the CDU is just waiting to implement even stronger reforms.

The UK is in an intriguing situation, both economically and politically. An ally of the USA, with hopes (pretensions?) of being a moderating influence on Bush, it is more disenchanted than ever with France and Germany (and therefore the euro). With unemployment at a Swiss-like 3.5%, its economy cannot be so weak as some commentators were saying just a month ago. The housing bubble is deflating, but not collapsing. UK consumers are pulling in their horns, but gently. The pound is finding sensible levels between the dollar and the euro. Blair could well end up a principled hero in the eyes of the electorate. The reward of fighting alongside the USA will be to participate in Iraq's reconstruction, a further fillip to the economy. On Blair, more than on Bush, will also fall the task of European reconciliation after the war, although we can hardly see French companies being lead participants in rebuilding Iraq!

A problem country is emerging as result of the Iraq conflict: Turkey. The temptation for the generals to invade "Kurdistan" is enormous, and US appeals and bribes will not stop them. A clear view from the EU could yet hold Turkey back, something like, "Invade Northern Iraq and kiss goodbye to the European Union". In the meantime, its bonds are extremely vulnerable. Brazil and Turkey have changed places in the bond market.

Recommended average maturity for bonds in each currency

We maintain our recommendation for maturities in euro to average ten years.

EUR/USD: 1.0670 remains the key level. After testing a low of 1.0503 so far, the euro recovered to a high of 1.0722. Consolidation in a 1.0550 to 1.0750 range is the most probable outcome

USD/CHF: Here, 1.3730/50 remains the key pivotal point. After testing a high of 1.4050, the market pushed the U.S. unit down to 1.3730. Consolidation in a 1.37 to 1.4050 range may be expected.

USD/JPY: As book closing is coming to an end in Japan and the new team at the BoJ is already looking for more stimulus measures, it looks like 117.- and below will still be protected by the MoF. Support has moved up to 118.80, and resistance is now at 121.10 and 121.80, followed by 122.50

EUR/JPY: Broad consolidation in a 125.50 to 129.50 range is underway, the euro coming off the lows and testing the upper side of the range again.

GBP/USD: Key level is at 1.5850. A low of 1.5535 has been seen so far. The next big support is at 1.5450. Only a weekly close above 1.5850 would open the door for a retest of 1.6100.

USD/CAD: Since key support at 1.5050 has been broken, the CAD remains one of the market's favourites. The next big support is at 1.4650 and 1.4580. Upside resistance is at 1.4850 and 1.4930

AUD/USD: Same comment: key level is around 0.5970/0.6000. Below this, the objective would be 0.5880, followed by 0.5830. Topside, a weekly close above 0.6000 would be needed to generate some renewed buying interest.