Bond Outlook [by bridport & cie, May 28th 2003]

Are Americans not amazingly optimistic? There they are, with a falling currency, rising unemployment and gaping deficits, even manifest failure so far in building the peace in Iraq, yet their confidence as consumers heads on up. The confidence data then wash through to the stock market, which makes substantial daily gains. Why should we find that amazing? Every one speaks of the USA being the largest, and most dynamic, productive and reactive economy in the world.


We accept that, but stubbornly believe that anyone, any organisation, any country, even a superpower, which continually spends beyond its means eventually has a price to pay. That price is being paid now and involves years of belt tightening, not months, both for the spendthrift and for those of us (the rest of the world) who did nothing while the spending binge was (and still is) on. If only someone at G8 had the nerve to point this out to the numerous US delegation.


Actually, there are subtleties in the consumer data which let us suppose that the American public can very well see what is going on around them, but that they are gullible towards Government propaganda. It is not the current situation that is giving consumers confidence, but their expectations about the future. Quite correctly they see darkness all around them, but persist in seeing light at the end of the tunnel. That really is precisely the point in the debate about deflation vs. inflation. Will the weak dollar, combined with cheap money and deficit spending bring about a corporate-led economic revival in the USA? We are prepared to say that it could, given time, not least because for three years now we have been saying that a weaker dollar was both inevitable and an essential first step towards rebalancing the world economy. Last week we made a guess that the impact of the weak dollar would take a year to work its way through to stopping deflation. With a little luck an improvement in the trade balance will happen in a similar timeframe. Then, even if there is some inflation, the Fed will be very wary of raising interest rates lest they kill the recovery. In the meantime, the Fed and Treasury are fiddling with the yield curve hoping to lower long-term rates. Our recommendation to stay long in bond maturities on both sides of the Atlantic is therefore appropriate - and that is even if the US Administration's economic management is successful.


Clearly we are not the only ones who have doubts on that score. The premium on index-linked bonds, even while many investors have chosen long maturities at poor yields, suggests a widespread "hedge your bets" attitude. Likewise, the recent strength in all parts of the bond market suggests many investors expect the bear market to resume. PEs at 33 on the S&P500 and 25 on the DJIA (on trailing earnings) certainly point that way given that profit improvement is being built almost exclusively on lay-offs and investment freezes. The top line for US companies remains flat or down.


The euro zone is of course much slower to react than the USA, and its governments nearly hopeless at reform. The expensive euro is already turning the trade surplus to deficit. The French have gone into auto-destruct mode over the pensions issue, and Germany is now still further along the path of copying Japan on deflation and recession. The UK will keep out of the EMU for the indefinite future, and probably survive quite nicely despite, or rather because, of that. The new EU members will do quite well, but their arrival will be deflationary, just as East Germany's joining the Federal Republic was. The low yields on candidate country bonds reflect the faith the market has in their success (even at cost to the older EU members).


Short-term rates will decline further: in Europe because the euro and the risk of deflation are too high; in the UK because the housing bubble is over and there is room and need for monetary stimulus; in the USA because neither the weak dollar nor the fiscal stimulus will have much effect yet.


Besides, the very principle of fiscal stimulus is completely out of place in the US economic situation. Keynes must be turning in his grave. The direct linkage imposed by econometric equations between internal and external deficits means that, while the weak dollar is addressing the latter, the irresponsible growth of the internal deficit actually causes the external to worsen. It behoves us to remember the over-riding consideration of US economic policy: "get George W. re-elected no matter what the future price".


Recommended average maturity for bonds in each currency


Stay long in dollars and euros, yields have to decline, except where the US Treasury issues (2-7 years).

As of 07.05.03

Dr. Roy Damary

Currencies (by GNI)
No change in view on trends: the only recovery seen for the US unit so far is profit taking on short USD positions.
And no change in view on the general situation. The G7 meeting made things very clear: US Treasury Secretary Snow declared that, so far, the US dollar's depreciation against the euro was to be considered modest. The supply and demand of market forces are to determine the value of the dollar. The Japanese authorities are also insisting on a weak JPY, by defending the USD/JPY 115.00 area with hidden interventions. Interest rate cuts are in the pipeline over the next couple of weeks, including a growing belief that the FED will act one more time.

EUR/USD: Same comment: every week, the bottom of the Euro is gradually moving higher, with 1.1550/80 acting as a major support now. 1.1750 is acting as the next resistance point, with 1.1820, 1.1880 and 1.1950.


USD/CHF: Major resistance on the upside is at 1.3070, with a clear break looking for 1.3280, or in an extreme case, even the 1.3400 area. The downside looks well supported at around 1.2880, 1.2820 and 1.2750.


USD/JPY: Once again, the BoJ seems to have won this battle of defending the USD/JPY 115.00 zone. On the upside the first resistance zone 117.50/80 has been taken out and is now acting as a major support zone. The next levels are 118.80 followed by 119.50.


EUR/JPY: The key support moved up from 135.50 to 137.70. Topside resistance is at 139.30, 139.80 followed by 140.50.


GBP/USD: Same: key support is holding at 1.6000 and has even moved higher to 1.6280. So long as the rate stays above this, the next levels are 1.6450, 1.6480 and 1.6550.


USD/CAD: 1.4030 remains the key resistance on the upside. After testing a low around 1.3400, resistance at 1.3750 was successfully taken out and levels above 1.3900 gradually reached. Current levels again look attractive to buy some CAD with a tight stop/loss in place at 1.4050.


AUD/USD: 0.6350 is acting as a major support now. Levels slightly above 0.6600 have been reached. Small support is around 0.6480.



Current spot level


Current spot level

   Main         ©