Since the sell-off after September 11, the stock market has moved up to a level at which it now seems relatively steady until two opposing forces resolve one way or the other: fear of further declines and hopes of an imminent improvement. In view of the continued poor news from the USA on corporate profits, lay-offs, not just lost confidence but real fear on the part of the consumer and empty shops except for discounters, we can only be astonished that the DJIA and S&P 500 are as high as they are. The average PEs are now 23 and nearly 27 respectively, levels which just cannot be justified when profits are declining.

In past bulletins we have noted the continual putting off into the future of the recovery. It has tended to be a steady "six-months hence", which happens to be just the right lead time to make equity investors stay with overpriced stocks because they have all read the books that tell you that the biggest rallies have always happened six months before the economy starts recovering. Now, however, the lead-time to the recovery has been pushed out at least to the second half of 2002. Commentators are converging on a view that foresees a "small v" in nine months' time, followed by sluggish growth. Could be. Our best guess, however, is in favour of more declines in fundamentals and stock price levels, with only a gentle improvement after both drag along the bottom for several months.

The response of the US Government continues to be that begun the day Bush took office: cut short-term interest rates, decrease and even return taxes, plus (since Sept 11) increase government spending. The Fed targets a very low overnight rate (now 2.5% and expected to go lower), while faced with a total reversal of public financing as deficit financing sets in. For several weeks, the yield curve has been pushed down at the short end, with the long end also moving down, but far less so. Such a situation cannot last when public financing is in deficit. As we noted last week, some commentators are looking for an upturn in long-term yields as a harbinger of economic recovery. Unfortunately it is also a signal of inflation, a danger we still see as greater than that of deflation, although that other real monster, "stagflation" is also lurking in the background.

The Fed is currently pursuing a very tricky path. To keep the short-end rate down, it has to buy government securities to expand money supply (by increasing banks' reserves and therefore lending capacity). Yet deficit financing means that the Government has to sell more T-bonds at the longer, even much longer, maturities. That has to lead to curve steepening with rates going up at the long end. The next step of the Fed will then be to raise the Fed rate because inflation will have reappeared. This scenario is one we can be confident of; its timing is another matter altogether. For the moment a long position on the yield curve is best, but fixed income investors must we ready to jump short with very little notice.

All this affects the dollar. An overvalued dollar can survive either a public deficit or a private one, but not both. A public deficit demands that private savings increase, and this seems underway. The US Government and Fed seem to be seeking three mutually exclusive phenomena: a budget deficit, high consumer spending and a strong dollar. It just cannot work.

Growth in Europe is slowing but remains positive. The ECB will follow the Fed down with its repo rate, but Europe will not, apparently, seek the fiscal stimulus that the USA has opted for. The euro zone will long be plagued by having monetary policy in the hands of an ECB which may be technically competent but is a PR disaster, while fiscal policy is hamstrung.

Readers hardly need reminding that these are times for quality in fixed income. Now that Railtrack has joined Swissair in inducing investors into thinking that their corporate bonds had a de facto, but illusory, government backing, appetite for corporate bonds is very low. Emerging markets are scarcely more attractive. If investors seek yield at reasonable risk, we can direct them today only towards Russia, for whom economic stabilisation and growth is coinciding with closer political ties with the West. In contrast, Argentina is wobbling again, and this time, so soon after the last bailout, the resolve of Congress will not be what it was prior to September 11.

Beyond the current military hostilities lies the unresolved issue of Israel and the Occupied Territories. Just as only a US economic recovery is so crucial to world economic recovery, so the hand of the USA on the antagonists in the Middle East is the deciding factor on this perpetual cause of so many ills

Recommended average maturity for bonds in each currency
Long positions should be maintained for the time being.

It is amazing to see how all equity and forex markets have continued to stabilise despite the air attacks carried out by the US and UK forces since Sunday. The 3rd quarter results by the major American companies issued during the course of the week confirm a sluggish US economy, with no relief in sight. The US administration has revised growth forecasts downwards for 2001 (from 1.6 to 1.1 1%), admitting that the 3rd and 4th quarter might be in recession. It is a question of time until Congress approves an additional $75 billion spending package to stimulate the economy. However, it is difficult to imagine that the markets will remain for long in this sort of consolidation mood, as further terrorist attacks are expected in retaliation for the current bombing in Afghanistan.

The G7 did not produce anything significant concerning the evolution of the yen, implying that they approve the recent round of intervention but are insisting that the BoJ is to act on its own. The Nikkei is trading again below the 10,000 level, and further uncertainties in the financial system still might block capital outflows and, even worse, bring about yen repatriation.

EUR/USD: Listless trading in a consolidation range of 0.9000 to 0.9300. Only a weekly close at one of these levels might provoke the next movement of 100 to 150 points.

USD/CHF: Here as well consolidation in a 1.60 to 1.6300 range. A weekly close of one of these two levels might provoke the next movement of at least 150 points. However, watch out any terrorist attacks, which would again cause huge safe haven buying of Swiss Francs.

USD/JPY: Despite the fact that we continue to favour a weaker yen over time, some consolidation in a 119 to 122. - range looks quite probable. Here also turbulence created by the attacks definitely favour a stronger yen and only the BoJ's intervention can prevent a sharp appreciation of its currency.

EUR/JPY: A broad consolidation range of 107. -to 112. 00 applies with the BoJ protecting the downside.

USD/CAD: Owing to recession fears, all commodity currencies are suffering at present. We prefer to take a wait and see stance. Support comes in at 1.5480 and next resistance area is 1.5780.

AUD/USD: Broad consolidation range to be expected between 0.4850 and 0.5050.

GBP/CHF: Extreme volatility will remain in this cross and only a clear break of the resistance at 2.3850 will open the door for its next target at 2.4100. Major support comes in 2.3550, followed by 2.3300.