Bond Outlook [by bridport & cie, May 29th 2002]

There are many risks in succumbing to the temptation of saying "we told you so" on financial markets, but we do indeed seem no longer to be a voice crying in the wilderness but to be expressing widely held views.

We just expressed them first!

  • The dollar has fallen and is continuing to flutter downwards against all other currencies as capital flows to the US fail to compensate the current account deficit
  • The euro is strengthening but held back by the slowness of reforms to a fully free market
  • The American recovery is weak and will remain so because of the dependency on cheap money
  • Inflation is moderate because of domestic and international price competition
  • The US internal deficit is growing but still proving easy to finance as liquidity has limited alternatives
  • Stocks are overvalued.


In addition, we have held the US Government to be irresponsible in pretending that all is well and that consumers should keep spending (and therefore increase their indebtedness), while the fundamental imbalances of the economy remain. Long-term readers may remember our expression of two years ago, "not by interest rates alone". Our argument then was that the best such an approach could achieve would be to delay the inevitable. In fact, Bush has done more than rely on interest alone; he has cut taxes and increased Government spending. Both worsen the fundamental problems.


We have not been right across the board: we expected consumer confidence and spending to fall long ago, but they have kept high. Thus Government policy has worked at a first level. It is at the second level, the return to sustainable growth that it falls short. We have not yet been proven right either in our view of Japan as a totally sclerotic economy, as recent yen and Nikkei strength contradicts us. Time will tell.


Equity investors are very reluctant to allow prices to reach levels based on historical PEs. After two years of getting nowhere fast with equities, however, scepticism must be setting in. Such scepticism can only grow in the light of corporate management's behaviour, and of the financial services world proving so resistant to criticism. We see stock options as a bell-weather of how management are putting their own interests ahead of shareholders'. Unfortunately corporations have been very successful with their lobbying to prevent stock options being recognised as an expense. The "principal-agent" problem identified by economists two centuries ago is now being seen again in the form of senior management granting themselves fabulous rewards regardless of performance. When Ron Sommers is booed by DT shareholders over Directors' compensation, and Chris Gent (sorry, Sir Christopher) takes a big bonus despite a record UK corporate loss, it can be seen that the problem is not just an American one. At least Chuck Watson of Dynegy has had the decency to resign as that scandal develops. The Fiat crisis rolls on with bank and government bail-outs proposed instead of now accepting the inevitable: sell Fiat Auto to GM. That, however, is another type of problem: old-fashioned unwillingness of family shareholders to let go. Look out for a Cantarella sacrificial lamb; Fresco should survive a while, bathing in the Jack Welch afterglow.


The next moves in interest rates have to be up, but every Central Bank is reluctant to move because they know how delicate the recovery is. In principle, the ECB focuses only on inflation (but we wonder how anyone could ignore the wider economic implications), and may be let off the hook by the strengthening euro keeping prices down. Neither the US nor the UK (the pound partly follows the dollar) has that privilege. Both are going to have to face dealing with a consumer overspend based on cheap money. Guess what will happen when money is no longer so cheap, and import prices not so low!


The yield curve shape, and the slowness of inflation in reasserting itself, allow us to maintain our 2007 average maturity, but with bar-bells for both dollars and euros.


The reader might well ask if we see only problems. We admit to seeing many, but for rays of hope we would cite a free market move in Euroland and the continued revival of the former Soviet economies, linked to vastly improved international relations.


Recommended average maturity for bonds in each currency
Bar-bell in dollars and euros, fairly long in Swiss Francs and Sterling.

As of 01.05.02
2007 bar-bell
2007 bar-bell

Dr. Roy Damary

Currencies (by GNI)


Sideways trading in its recent trading bands continues to dominate the equity and forex markets, with the bottom of euro gradually moving higher, consolidating its recent gains. Investors still favour gold and all the commodity currencies, which are testing levels not seen for a long time in this still tense geo-political environment. Our first targets in EUR/USD and USD/CHF have been reached. It remains to be seen if this trend will continue, especially when now all major banks are changing their forecasts and looking for a still lower USD.


EUR/USD: The bottom of the euro has moved up from 0.9000 to 0.9140, which is now acting as the first strong support. The "buy on dips" strategy remains popular, and our target, given a break of 0.9280, is 0.9330/50. A weekly close above the latter level would encourage those investors who are oriented to the medium term to turn bullish and consider buying some more euros, targeting 0.9550.


USD/CHF: Our target has nearly been reached, but the upside still looks very heavy, with 1.5950 clearly capping all attempts. A clear break of 1.5650 would target 1.5500, followed by 1.5350


USD/JPY: Continued selling by Japanese exporters above 125.-- is capping the upside. The downside remains well supported at 123.50/124.--, reflecting threats of direct intervention by the BoJ.


EUR/JPY: 114.50 remains the key support, which looks likely to hold for the time being. Any loss would immediately push the exchange rate down direction 113.--. The upside is 115.80, 116.30 and 117.00.


USD/CAD: All commodity currencies are continuing their rallies. The next targets are 1.5280, 1.5220, followed by 1.5100. There is major upside resistance around 1.5480.


AUD/USD: The rally in the Aussie has continued and no technical correction been seen, our target of 0.5650 having been reached directly. Next levels would 0.5730 and 0.5780. The downside should remain well supported around 0.5500.


GBP/CHF: Sterling continues to be under pressure and 2.3250 is acting as a very strong resistance. Next targets are 2.2850.followed by 2.2600



Current spot level
Current spot level
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