Bond Outlook
[by bridport & cie, August 29th 2001]
The invisible hand of Adam Smith is functioning. As we foresaw
three weeks ago, it is doing its job of bringing the American consumer
back to sense of reality in his/her confidence, spending and savings
habits. This reinforces the view that "scenario III" (a long recession
without inflation, as we spelt out in May) best describes the state of the
US economy. The rate cut "medicine" continues, but the patient does not
respond. His illness needs time for him to address the imbalances about
which we have so much spoken these recent months. History will look at
this period as one of curious irresponsibility on the part of the US
authorities, when they have done everything they can to encourage spending
instead of saving. How intriguing it is to see the ghost of Adam combat
the wisdom of Alan! |
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Let us suppose that it has now sunk in that the USA will be in a
downturn of greater severity and duration than generally expected a year
ago. The stock markets have further corrections to go through to reflect
this realisation, and the dollar has considerably further to fall. Indeed,
another major realisation of recent days is that most of the productivity
miracle in the USA was a mirage. Even the part of it which was real can
only explain a tiny proportion of the dollar's appreciation. In fact, the
dollar's exchange rate is as cyclical as it ever was. It suffices to
recall the extremes of recent years to realise that the USD can be fully
expected to fall below parity with the euro next year. Moreover,
calculations by economists to see what exchange rate is needed to halve
the US trade deficit suggest several cents above parity for the
euro. |
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Much is being made by the press about the worldwide nature of the
growing recession. All major economies, with the possible exception of
China, are moving down in parallel. The dependency of almost every economy
on the "US motor of growth" has been widely accepted, to the point where
the assumption is that there is no hope of recovery without the USA
leading the way. That assumption is one we would like to challenge, at
least in its extreme form. |
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In our worldview, there are three economies with inherent demand
for goods and services: North America, Japan and Europe. The rest of the
world is basically in the business of supplying these three. The first
consumes a lot more than it supplies, the second supplies a lot more than
it consumes, while only Europe has a reasonable balance between what it
buys and sells to the rest of the world. The ageing population of Japan
and the poor macro-economic management of the aftermath of its 1980's
asset bubble put Japan hors de combat for the foreseeable future. That
leaves Europe as the only chance for a consumption-led expansion in
economic activity. At this point, conscious that this is an area where
opinions differ greatly, we come down in favour of a modest degree of
optimism for Europe, as expressed in last week's bulletin. Recent German
economic data give rise to the hope that the Euroland economy is bottoming
out. The ECB has the potential, almost the obligation, to cut interest
rates. The new deal between VW and the Unions could be a precursor of more
sensible labour and social policies in Germany. The UK inside the EMU will
be a reforming force. But, above all (and sorry to be repetitive, readers)
the "euro in the pocket" will give a powerful tonic to the European
economy. We therefore nail our colours to a European mast. To say Europe
will drag the world out of recession would be to go too far, but Europe
may be expected to play a major role in economic recovery as this
recession runs its course. |
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Last week we mentioned our belief that Russia was the most positive
emerging bond market. It is "furthest" from the dangers of contagion from
Argentina and, more importantly, it is an economy on the mend. It is true
that the country plumbed extreme depths before starting to turn round, but
that recovery is firmly underway. Russian bond spreads came in last week,
and that is pleasing after our recommendation, but our positive view on
that economy is long-term one. |
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Our scenario of a "hunkering down" of the world economy, with
further cuts everywhere and the risk of deflation actually being greater
than the risk of inflation, speaks well for the bond market. The obvious
interest of rebalancing in favour of the euro has been recognised by many
of our clients. |
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Recommended average maturity for bonds in each currency
(changed 08 and 15.08). Now that we have made the move to
long positions, we see this as being held for some
time. |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
08.08.01 |
2006 |
2006 |
2007 |
2010 |
As of
15.08.01 |
2008 |
2006 |
2011 |
2010 |
|
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Despite a still solid housing sector, yesterday's consumer
confidence came out much lower than expected. Housing and consumer
spending are the two main components that have so far prevented the US
economy from slipping into recession. Today's 2nd quarter GDP
revision could well show zero growth and add some additional pressure on
equities and the dollar. |
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A much higher M3 in Germany could postpone the long awaited rate by
the ECB on Thursday. |
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Europe continues on a regular basis to revise GDP numbers
downwards. |
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The market behaviour remains negative on the dollar and the
strategy remains to sell the USD on rallies. |
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No change regarding Japan. More and more repatriated capital flows
are being detected in the context of the book closing end of September,
and of covering losses from a battered Nikkei. Repeated verbal
intervention by monetary officials to weaken the yen remain ineffective
for the moment. Only a rapid move below USD/JPY 118.00 might provoke the
BoJ to step into the market. |
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EUR/USD: Consolidation in an expected
range of 0.9010 to 0.9250. A clear break would bring about the next
movement of at least 100 to 150 points. |
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USD/CHF: 1.6500/30 remains a
major support area. A weekly close below opens the door for the next
target at 1.6350 followed by 1.6100,. 1.6800 is capping the upside for the
time being. |
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USD/JPY: The verbal interventions by
the Japanese authorities have put a floor at around 119.00, but sooner or
later capital flows might test the resolve of the BoJ. Any loss of the
support area at 118.00 should cause rapid movement in the direction of
115.00. USD/JPY 121.30 still acts as a major break out level on the
topside with first target of 123. |
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EUR/JPY: Consolidation is continuing in
a 108.50 to 111.30 range. Despite the fact that we see a higher EUR/JPY
over time, short term appreciation of the yen cannot be excluded.
|
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USD/CAD: We keep our short position
established at 1.5480, S/L 1.5480 and T/P at 1.5350. |
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AUD/USD: The break at 0.5280 has put
the Aussie on a positive path. Next target on the upside is 0.5380,
followed by 0.5550, while 0.5280 is now acting as a major
support. |
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GBP/CHF: Consolidation in a 2.3850 to
2.4200 range. 2.4350 is acting as a break out level, while long term
support comes in at 2.3700. |
|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.6680 |
0.9250 |
1.5250 |
121.30 |
111.00 |
Current spot
level |
1.6620 |
0.9220 |
1.5195 |
119.65 |
110.25 |
Support/Breakout |
1.6450 |
0.8900 |
1.5050 |
118.00 |
108.50 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5410 |
0.4510 |
1.5550 |
1.4650 |
283.00 |
Current spot
level |
0.5300 |
0.4415 |
1.5400 |
1.4550 |
273.00 |
Support/Breakout |
0.5230 |
0.4330 |
1.5350 |
1.4380 |
268.00 |
|
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