
Bond Outlook
[by bridport & cie, September 26th 2001]
Financial markets are now subject to three main
forces: |
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- 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.
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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. |
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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. |
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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. |
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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. |
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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". |
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Recommended average maturity for bonds in each currency
(still as on 15.08). |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
15.08.01 |
2008 |
2006 |
2011 |
2010 |
|
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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. |
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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. |
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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. |
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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. |
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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. |
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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. |
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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. |
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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 |
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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.
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USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.6250 |
0.9280 |
1.5010 |
120.10 |
110.50 |
Current spot
level |
1.5970 |
0.9220 |
1.4720 |
117.90 |
108.65 |
Support/Breakout |
1.5880 |
0.9030 |
1.4650 |
116.80 |
105.50 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.4880 |
0.4180 |
1.5780 |
1.4780 |
295.00 |
Current spot
level |
0.4960 |
0.4095 |
1.5715 |
1.4720 |
291.50 |
Support/Breakout |
0.5050 |
0.4040 |
1.5480 |
1.4500 |
278.00 |
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