Just last week we were struggling with the question of whether there would be inflation in the USA or not, leaning towards a "no" answer, but still hesitating. Now that the Fed has reached the same view, we are confident that the anti-inflation forces of spare capacity, rising unemployment, foreign competition and falling commodity prices will overcome the inflationary forces of a falling dollar. The Fed has returned to an easing bias, implying a possible cut in the overnight rate. This, however, may be too difficult to achieve in view of the Treasury's policy of borrowing at 2, 5 and 7 years, in the hope of keeping down the yield at the long end of the curve, or taking it lower. The Treasury policy to deal with the budget deficit, leading to excess medium-term supply, suggests that five years is not the place to be. What average maturity should therefore be recommended? "Very short", the view of many of our clients, is one possible answer, to avoid the loss of value as 2-7 year yields rise, but, of course, returns are very low.

The alternative is, however, to go as long as possible on the basis that the US economy is seriously damaged, inflation subdued and the Treasury policy will indeed raise the yield curve only over the 2-7 year range. The common wisdom in the USA is that only lower long-term rates will encourage corporations to invest, so the Fed, presumably under the Administration's influence, wants to generate an expectation of low inflation. This is a dangerous and difficult game, juggling the inherent contradictions of loosening money supply, cheapening long-term debt and financing a huge and growing deficit, all in the context of a weakening dollar. There is the additional danger of lowering inflation expectations so much that the economy falls into deflation. All these reasons are now making us move our "5 years, watchlisted 10" for the USD to a formal recommendation of ten years, matching the recommendation for the euro.

Financial markets are going through an unusual period. While fundamental data are universally negative on both sides of the Atlantic, stock markets have gone up, more so in Europe than in the USA, and spreads both on corporate bonds and on emerging markets have come sharply in. Our view is that the flight to quality before the Iraq War is now being reversed, especially in European share prices, which are coming back from greater declines than in the USA. There could even be some positive reasoning in that both the French and German Governments are talking reform of social benefits (and costs), and an ECB rate cut has to happen soon. Justified or not, risk appetite is rising, even as the economy is declining. Have corporate bond spreads further to come in, especially at the lower end of the investment grade, which has performed best in recent months? We incline to a "yes" answer so long as the equity rally continues, but that could peter out any day as reality triumphs over hope.

Where we do find reasons for optimism is the fall of the dollar leading to an export-led recovery in the USA (that does not contradict our above analysis - it takes a couple of years for the effect to work through), and to putting more pressure on irresolute governments in Europe to reform.

We are beginning to see the long-foreseen weakness of the dollar as "fin d'йpoque" (that means "end of an era", but it sounds better and has historical connotations!). For about seventy years the standard expression to describe the foreign exchange holdings of nations has been "gold and dollar reserves". With gold taking a smaller place in reserves and the euro a greater role, we will soon be referring to "dollar and euro reserves". International trade has largely been conducted in dollars. That role is now being shared more and more with the euro. The lesser role of the dollar will however be but a symptom of the most fundamental change of all, viz. that the USA steps out on the long path towards living within its means.

Not that George W. and friends see any of this in their worldview. "Living beyond their means" is a way of life for them. Let the Federal deficit blossom; let the Social Security gap explode; encourage households to increase their indebtedness! Future generations can pay for this generation's profligacy. Well, George W., not all your compatriots go along with that approach, and the rest of the world certainly does not. Yet in the end what matters is what economic forces do, and they have already started to act.

The Administration proposes lowering corporate tax on repatriated corporate profits for a limited period. It smacks of desperate measures to us.

Recommended average maturity for bonds in each currency

To our recommendation for maturities in euros to average ten years, we add the dollar.

EUR/USD: The trend remains clearly oriented to the upside with 1.1630/50 being projected as the next target. We still rather expect a short-term correction, with 1.1380 as the first support, followed by 1.1310. Only a clear break below the latter level would bring about a deeper correction direction to the 1.1010/50 area. A lot will depend on the ECB and by how much the expected rate cut is going to be.

USD/CHF: Not only was the critical support zone at 1.3480 been broken, but the recent outstanding low at 1.3230 has also been tested. The next support is around 1.3130/50, with 1.2800 as the next big level on the downside. The short-term technical resistance level is at 1.3380, with a clear break opening the door for the 1.3650/1.3750 zone.

USD/JPY: Despite verbal intervention and new measures being looked for by tomorrow, the USD/JPY broke the first big support at 117.80 in sympathy with the other currency pairs. The next support is at 116.50, 115.80 and 115.10. As Japan is like the USA in seeking a weaker currency, it has to be seen if the BoJ is showing its teeth in intervening close to 115.00. A weekly close below 114.80 would be catastrophic, and send the USD/JPY much lower, in the direction of 110.--

EUR/JPY: 133.50 is acting as the major support now, with our objective of 134.50 nearly reached. The next resistance is at 135.00, 135.50 and 136.50. A weekly close below 133.50 would send this cross immediately down, direction 131.50

GBP/USD: The support level has moved up from key 1.5850 to 1.6000. So long as the rate stays above this, the next levels are 1.6150, 1.6230 and 1.6350.

USD/CAD: The high yielders remain the market's favourites. With the BoC still leaving the door open for further interest rate hikes, the 1.4350 support area broke to reach a low around 1.3830. The next big levels are 1.3780, 1.3650 and 1.3550. Upside resistance is at 1.4030 and if broken, 1.4350 would be the key resistance

AUD/USD: Our target of 0.6350 has been reached and acting as a major support now. 0.6445 has already been seen, with 0.6480 and 0.6550 the next targets