BRIDPORT INVESTOR SERVICES WEEKLY
 

Bond Outlook [by bridport & cie, November 7th 2001]

We thought that last week was to be the beginning of unwinding the tensions in financial markets, such as high stock valuations in parallel with a flight to quality in bonds. However, the widespread faith (and we deliberately choose the word "faith" over "belief") in a strong rebound in the US economy in the second half 2002 has not yet been dented. In fact, the nearest thing anyone can offer as good news is that a given decline in profits is somewhat less than anticipated. Lay-offs continue, consumer confidence is declining and, above all, corporations are investing little because they have over-invested. A lowering of interest rates, even to the negative short-term real rates now in place, cannot make corporations buy what they do not need. Neither can it make consumers buy durables or take holidays when they fear job losses. Yes, free automobile financing can push them to bring forward car purchases, but only with the risk that car sales will drop drastically once the special deals are over.

 

What will make corporations invest again? Only time and rebalancing of expenditure to debt, an argument we have put forth in this weekly for many months (avid readers will remember that we called it "not by interest rates alone").

 

Will the renewed interest in Keynesian economics (with governments picking up the slack of reduced private sector spending) achieve what interest rates alone cannot? The US Government's budget surplus has moved into deficit, and Europe will follow the US into extra public spending, even if more slowly. The forecast US deficit ($50-150 billion) is affordable in a $ 40 trillion economy. It will bring positive results, just not so quickly as financial markets are wanting to believe.

 

Deficit financing implies competition for money between the private sector and the Government. When there is much money available as today, there is no problem with that. The Government can borrow easily at almost any maturity, and cheaply, too, taking cash out of the economy but causing neither inflation nor its sister, higher interest rates. But all that holds only so long as the private sector is in the doldrums. If an economic recovery is further away than mid 2002, then the US policy of rate and tax cutting, and increased Government spending can continue. When the policy does finally work, however, expect a rapid turnaround in interest rates. Do more than "expect" - hope and maybe even pray! Because there is probably only another 0.5% available for further cuts in the Fed rate, and if "traction" is not eventually achieved, the USA and the world will be in almost as much trouble as the only other country with very low interest rates plus a Government deficit: Japan. With this reasoning, we are tempted to paint a scenario of a return to growth at the end (not the middle) of 2002.

 

Corporations are taking all they can from the corporate bond market, but only those corporations with the best credit ratings. For them the money is cheap, for the investor, the spread over Treasuries sufficient. Corporations are behaving just like the Government, "we can sell our bonds for low rates, so let's do it!". What a pity that the corporate cash thus raised is being used for current cash flow purposes to compensate poor operating cash flows, rather than to finance new investments.

 

According to S&P, Argentina is now in "technical default", which means the proposed restructuring breaks the terms of existing issues, although as yet no interest or principal payments have been missed (no foreign currency payments are due anyway before February 2001). Domestic bondholders have no real choice but to accept, while foreign lenders will ensure that the word "technical" is shortly replaced by the word "real". That is partly because a solution involving subjugation to Argentinean law is perceived as worse than bankruptcy.

 

The extreme dependency of the world economy on the USA is now very obvious. Europe's decline is following the USA's, with the UK being the last to be sucked along. We still allow ourselves some moderate optimism that the smaller imbalances in Europe will let the economies decline by less than in the USA. We would, however, have to be very optimistic to suppose that interest rate cuts in Europe can achieve real results before the USA turns round.

 

Conclusion: settle down for a good year of lack of growth and stay long on the yield curve as the economic recovery and higher yields are both a long way off as we currently see it.

 

Recommended average maturity for bonds in each currency
Stay long.


Currency:
USD
GBP
EUR
CHF
Virtually unchanged since 15.08.01
2008
2006
2011
2011

Dr. Roy Damary


Currencies (by GNI)

 

After an additional rate cut by the Fed from 2.50% to 2% for Fed Funds, the pressure on the ECB to follow suit tomorrow is mounting. Last week's decision by the US Treasury no longer to issue 30-year bonds came as a surprise, with the effect that yields have come off since then by nearly 0.50 %, especially for the longer dated maturities.

 

EUR/USD: The 0.9000 zone remains the mid point. After managing to stay above 0.9000, the next target is 0.9150 followed by 0.9240 and 0.9280. The major support zone is 0.8800 to 0.8850. The short term favours the upside.

 

USD/CHF: Sideways trading is expected to continue in a broad consolidation band of 1.6100 to 1.6600. Key resistance and breakout level on the topside is still 1.6500/30. On the downside, minor support is at 1.6210, followed by 1.6150 and 1.6080, before the psychological barrier of 1.6000.

 

USD/JPY: In the short term, we continue to favour range trading in a 120.00 to 123.00 range. Fear of BoJ intervention puts a solid base below 120.00 , while break out level is above 123.30.

 

EUR/JPY: A broad consolidation range of 107.- to 112.00 is in place with the BoJ protecting the downside.

 

USD/CAD: Continued weakness in the US economy is hurting Canada's exports, and trade disputes on lumber are putting the CAD under pressure to reach nearly our target of 1.6000. We would use this excessive weakness to buy some CAD (50%), doing the second half at 1.6080 with a S/L at 1.6200.

 

AUD/USD: The Aussie has created a solid base above 0.5000 but now needs a weekly close above 0.5180/30 to progress further direction 0.5280.

 

GBP/CHF: Extreme volatility will remain in this cross. The GBP managed to go through resistance at 2.3850, with the next target at 2.4100. Major support comes in 2.3550.


USD/CHF
EUR/USD
EUR/CHF
USD/JPY
EUR/JPY
Resistance/Breakout
1.6350
0.9080
1.4880
123.10
112.00
Current spot level
1.6310
0.9015
1.4700
120.95
109.00
Support/Breakout
1.6130
0.8950
1.4650
119.80
108.80
AUD/USD
NZD/USD
USD/CAD
GBP/USD
XAU/USD
Resistance/Breakout
0.5180
0.4280
1.5990
1.4680
283.00
Current spot level
0.5150
0.4210
1.5930
1.4650
281.00
Support/Breakout
0.4980
0.4080
1.5750
1.4480
272.50
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