The sense of hiatus to which we alluded last week remains, particularly as to whether or not bond yields will break out on the upside. To give you our conclusion first, it means that we can make no recommendation yet to lengthening in the Western currencies, but we shall discuss below some considerations on yield curves' shape.

One of those considerations is the Japanese yield curve, a topic we rarely comment on, but which has a major impact on Western financial markets. The improved attractiveness of JGBs, the ten-year yields of which have increased since June this year from 0.45% to 1.65%, understandably deflects Japanese demand from foreign bonds to domestic. The effect is then paradoxically multiplied by the very volatility in JGB prices (increased domestic risk means reducing exposure to foreign currency risk). Recently we have pointed out that the US deficit is being financed by both Japan and China taking up US Treasury bond issues, and questioned how long their respective Governments can and wish to keep up this effort. In Japan, it must be a case of the public authorities moving against the flow of private domestic and foreign capital. Currently this phenomenon is affecting the euro before the dollar, but the key point is that the yen is again under great upward pressure.

China, too, is under considerable pressure to revalue, with both the Chinese Government and the forward market of the renminbi signalling that there will be at least some modest concession to that pressure. The USA is therefore in the extraordinary situation of being dependent on these two great trade rivals for the maintenance of its currency - a sword of Damocles which the Democrats will surely point out, perhaps adopting the jibe found in the FT that Bush is the "Manchurian candidate for re-election".

The US recovery now underway is lukewarm because of the spare capacity and continually increasing unemployment, constrained by its dependency on cheap money, and fragile because of its dependency on foreigners' good pleasure. Nevertheless, markets clearly perceive the recovery as sustainable, pushing up bond yields and stock prices. So long as they hold that belief, the risk on bond yields is biased towards the upside. This is true of Europe also, where despite every attempt by France to work (or rather not work - remember the 35 hours week) itself into a recession, the economic signs in Germany are not so bad at all; even Business Week thinks it!

Upward market pressure on yields purely from an economic recovery would be very welcome. It is the second pressure, Government borrowing, which is the barrier to sustainable expansion. Both these pressures, present on the entire 1-10 year range of the yield curve, imply a still sharper rise in the money-market part of the curve (as Central Banks anchor the overnight rates at "unnaturally" low levels). The entire bond portion of the curve is therefore flattening, led by the short end. The third source of upward pressure, the latent risk of inflation from a weak dollar and higher commodity prices has not yet, however, made itself felt at longer maturities.

Emerging markets have been increasingly popular among bond investors. They have given a relatively safe means of obtaining respectable yields in a low-yield environment. Many of our clients are now taking profits on this part of their portfolio, particularly in those markets that might be called "newly-emerged" (Asia) rather than those "still emerging". Their attention is switching to countries for which the word "emerging" still applies reasonably well, but probably not for much longer, such as Russia, Turkey and Brazil.

The Swedes are very likely to vote "NO" to the euro. The Growth and Stability Pact is being treated with the contempt it deserves. It is inconceivable that the UK public come round to favouring the euro so long as the UK economy steers this quite clever route between the USA and Euroland. Nevertheless, the euro is still becoming a secondary reserve currency (which is not all to the good as its value may be too high for industry). The change of ECB Governor will be an interesting tale to watch.

Recommended average maturity for bonds in each currency

Stay short until intermediate yields have met clear resistance, or broken out to new sustainable levels.