Financial markets are now subject to three main forces:

• the trend before the 11 September
• the direct consequences of the terrorist attacks (consumer confidence, travel, insurance, etc)
• the development of both the US and the world's response.

In this last regard, at least, there is room for moderate optimism, as a united front is being built and a clear distinction being made in the West between Islam and terrorism. Our expectations are that there will be a strike against the Taleban, but focused on training camps, military command and control centres, and other strategic targets. Special operations apart, foreign troops on Afghan soil hardly seem necessary. The Northern Alliance is increasing well equipped (with Russian and US arms!) and itching to take their country back from the Taleban, who in turn are showing every sign of military and political disarray. Today we are therefore fairly sanguine about the military developments in terms of maintaining the focus. There are even positive geo-political developments underway, like Russia and the CIS being totally "on-board", Iran speaking courteously to the West via the UK and seeming wanting to play a responsible role, and a degree of moderation being imposed on or accepted by Israel.

But to return to the other two main forces acting on financial markets: the underlying economic situation has been worsening, slowly and steadily, for almost two years. Equity markets have been giving little or no return for at least as long. The US economic policy has been based on a reliance on consumer spending to promote growth, while fundamental imbalances are dismissed as of no importance. We have long therefore believed that both the economy and share prices had to get worse before getting better. We would therefore still be talking bearish today, even without the terrorism. Now we can but point out that all the old downward trends in the USA have been reinforced by 11 September: reduced travel, less eating out, less purchasing of goods, still more restraint on investments. It is now more likely that military spending will eventually turn the economy round than consumer spending.

Yet our pessimism (or realism) knows its bounds. The lower dollar will help the US economy. So will lower oil prices, provided they last. If the US consumer now spends in a proper relationship to his/her revenue, a macro-economic balance should return. The big remaining issue is US stock values. Sorry, but they are still much too high, historically, in comparison with other countries, and in terms of any value calculation taking into account likely profits growth and equity risk premium. The PEs of the SP 500 and the DJIA are in the 20-22 area. That compares with 14-16 on Continental bourses and 15-17 on the FTSE 100. Already in August we were expressing moderate optimism about Europe. Its economies had not overreached so much as the USA's, and should therefore turn round more quickly. Europe has a new currency about to go into everyone's pockets, and not just the inhabitants of the euro zone! All these arguments were valid before, but are now reinforced. The ECB has more room to cut interest rates than the Fed, and less risk of inflation, as the dollar and oil prices fall (again, if that lasts). Moreover, in Europe, investors can find shares at prices reflecting good fundamental value.

Interest rates will be lowered further, and yields curves will steepen further, but not so much as many would suppose. There is, of course, a risk of inflation, but it is moderate enough and sufficiently into the future that our recommendations on maturities remain unchanged. Spreads on corporates and emerging market sovereigns have continued to widen, and the move to quality is reinforcing this trend. We note that Russian spreads have suffered relatively little. There has been some speculative buying of Swissair bonds under the assumption that the Swiss Government is standing by if things get too out of hand.

The FT has published a simplistic proposal to solve Japan's problems: simply declare that the exchange rate will be 20% lower and that inflation will be positive! Nice idea, but difficult to pull off while the Japanese are repatriating those T-bonds and the trade balance remains positive. Not to mention the ageing population unwilling to spend, the bankruptcies not being allowed to happen and the bad debts not being written off. It is hard for us in the West to gauge how long Koizumi's long hair and love of Elvis can compensate his talk without action on reforms. The question whether he will act, or will be able to act, before patience runs out, remains open. But no matter how long he has or takes to lead reforms, Japan will not be the source of the world's economic salvation. For that look to a mixture of US military spending and moderate strength in Europe, all helped by the next stage of that long-term act "Russia and its allies joint the Capitalist World".

Recommended average maturity for bonds in each currency (still as on 15.08).

After the severe sell off in all equity markets last Friday, the Swiss National Bank decided on Monday to lower interest rates a second time in scarcely a by a further 0.50%. They clearly stated their unhappiness with the appreciation of the Franc and that they would do everything possible (direct market intervention, verbal intervention or lower rates once more) in order to prevent further safe haven inflows to Switzerland. This objective may, however, be very difficult so long as there is such uncertainty about how world-wide equity markets will behave in the light of US military action and its possible repercussions.

The BoJ continued to intervene, essentially on its own, but assisted this week for the first time by the ECB. On Monday, the BoJ not only bought USD/JPY but also EUR/JPY. They are clearly showing their determination to fight off an appreciating yen and want to prevent the USD slipping below 116.00 and the EURO/JPY below 106.00. Over time they will succeed, but further shaky stock markets might lead to additional capital repatriation.

EUR/USD: The crosses EUR/JPY and EUR/CHF are still preventing the EUR/USD from moving higher. There is solid support in the 0.9030/50 area. On the topside, a weekly close above 0.9280 is needed for a further advance towards direction 0.9400, followed by 0.9550.

USD/CHF: Safe haven buying of CHF and a lot of stop losses continued to cause further CHF appreciation. A determined SNB helped the dollar to recover from 1.5650 to reach 1.6000 again. The downtrend nevertheless remains intact for the time being. Nervous volatile trading will continue with good selling interest maintained in the 1.6150 to 1.6300 zone. Solid support comes first at 1.5760, followed by 1.5550.

USD/JPY: So long as the rate is below 118.00, the downside objective remains 115.50 and only regular BoJ intervention is preventing the yen from appreciating to this level. The willingness of the Japanese monetary authorities to weaken the yen is still firm. Any huge sell off direction 115.00 or below should be used to establish a long USD/JPY position. Upside resistance is at 119.00 followed by 121.30 major.

EUR/JPY: Owing to continued capital repatriation, this cross should remain in a large consolidation range of 105.50 to 111.--. A lasting strength of the yen with levels below 106.-will push the BoJ to intervene, while levels above 110.-are still used by Japanese exporters to sell EUR/YEN.

USD/CAD: Because of recession fears, all commodity currencies are suffering at present. Despite the fact that levels above 1.5700 represents a good buying opportunity for CAD on a medium-term basis, we prefer to take a wait and see stance. Support comes in at 1.5480 and the next resistance area is 1.5780, followed by 1.5900.

AUD/USD: A broad consolidation range is expected between 0.4850 and 0.5050. Only a clear break of its resistance at 0.5050 on a weekly basis might take off the pressure on the battered Aussie. Next targets on the downside are 0.4830 and 04750

GBP/CHF: Safe haven buying of CHF in a uncertain market environment pushed GBP/CHF to a low of around 2.2800, but it has recovered in the meantime to 2.3500. Extreme volatility will remain in this cross and only a clear break of the resistance at 2.3850 will take off the pressure and head for its next target at 2.4100.