By many measures, this week is just a prolongation of everything that has been happening since the beginning of the year: accounting doubts spreading, investor confidence shaken, Enron executives proclaiming innocence yet claiming their right to silence, corporate bond spreads widening and the fear of Argentinean contagion persisting. However, there is a new development: the issuance of corporate bonds has dropped dramatically (by a factor of three) in the USA and is expected to stay at this new, low rate for the foreseeable future. In Europe, the drop is less severe (in the order of 25%), but the principle is the same: fewer opportunities and/or need for corporate debt financing and therefore for corporate investment.

Corporate investment has been one of our main sticking points over accepting the endless optimism put out by American officials and investment advisers. They keep telling the corporate managers to get on with investing, then all will be well. However, as witnessed anecdotally by the divergence between the "government" and "corporate" views at the World Economic Forum meeting in New York, and now supported by the new data on corporate bond issuance, the corporate managers are not following the party line. US Government policy remains, "Keep spending, consumers, and corporate investment will catch up". Reduced corporate bond issuance can be interpreted in two opposing ways. Some say that it means that corporations will be making sufficient profits and have such positive cash flows that they do not need to borrow. Others, including our sceptical selves, see this as a demonstration of how few opportunities or what little motivation corporations have to invest.

One implication of reduced corporate bond issuance is that spreads may narrow because of shortage of supply. Many commentators therefore expect a good performance from corporate bonds. We are as sceptical about that recommendation as we are about a short-term economic recovery. The corporate sector is over-indebted; bankruptcies are now so commonplace that they pass with little comment (Kaiser Aluminium as we write) and agency downgrades exceed upgrades by 4.5 to 1.

The strength of the dollar, in the face of a massive trade deficit, remains dependent on overseas fund inflows to the USA, (mainly for Treasuries and for stocks). There are signs of a weakening fund flow. However, USD strength may persist because international investors have little alternative. The yen is too volatile and offers negligible yields. The pound is a close dollar substitute but has the imponderable of the EMU hanging over it. The euro should be the great alternative. We have indeed had high hopes, but seen them dashed many times. New data on euro zone economic fundamentals tell us partly why. Productivity per person in work in the euro zone is behind the USA's, but not desperately so, at 87% of the US level. However, GDP per capita comes in at only 67% of the USA's. That significant 20% difference is explained 8% by there being less people in work (over half of that being because of unemployment), and 12% by euro zone citizens working less hours in the week and less weeks in the year. So bravo once again, France, for making the gap still wider by interfering with the basic human right to work as hard and be rewarded as well as people wish.

So where can an investor find a respectable risk/return profile? Our first answer is that the question is inappropriate in today's climate. Ask rather, "How may I protect my capital?" These are defensive days.

For the courageous who still seek yield, certain emerging markets remain attractive for well-informed investors. Even then, South America is not in a happy state and the politics of the Middle East and of Pakistan/India are extremely unstable. The Pakistan Eurobonds are at approximately 95, up from the mid-70s on September 11^th. They are a clear sell.

Our ideas about the future shape of the yield curves are evolving. From an earlier view that demand for long term debt with recovery will push up long-term rates, we are moving to a view that sees a flattening of the curve, with a pivot point at five years or so. If this proves correct then lengthening will be appropriate. We cannot, however, make this recommendation yet as the risk of a double dip recession in the USA is still too high. We therefore recommend staying short, but with readiness to lengthen or bar bell with floaters should traction be achieved in the short term.

Recommended average maturity for bonds in each currency
Stay short, including FRNs.

The market is continuing to take a wait and see attitude, fluctuating in broad trading ranges. The USD is still well supported, with little progress one way or the other. In general, the overall sentiment is to trade on the basis of a recovery in the USA, despite a still mixed bag of economic data and many questions about accounting practices, e.g. the Nortel chairman dealing in own company shares.

In Japan, investors sold a total of JPY 3.1 trillion foreign bonds in January alone. The Government is artificially supporting the equity market and Bush is visiting this weekend. These events all speak for the likelihood of short-term yen appreciation. Investors should take advantage to re-establish a short JPY position on any big setback.

In Europe, EU enlargement plans as of 2004 have been announced with an initial cost estimate of approximately EUR 40 billion. In addition, Germany not being warned on its rising budget deficit does not exactly inspire confidence.

EUR/USD: A broad trading band of 0.8500 to 0.9000 seems to be developing. Key support is at 0.8480 and key resistance at 0.9030, with pivotal point at 0.8750. Most probably the market willt try to sell euros again in the 0.8850 to 08950 area.

USD/CHF: So long as the rate stays above 1.6750/80, the U.S. unit remains clearly oriented to the upside, with resistance at 1.6950, 1.7030 and key 1.7250. Only a weekly close below 1.6750 would put the bullish outlook into doubt and speak for a deeper correction, first down to 1.6550.

USD/JPY: No change. For the time being, the yen is trading in a consolidation range of 131.50 to 135.30. A clear move below 131.50, would temporarily open the door in the direction of 130.00. Levels around 130.00 should represent a good buying opportunity for medium to long-term prospects, with our first target of 136.90 followed by 140 still valid.

EUR/JPY: We closed down our long EUR/JPY position at 117.20 (+280pts). We prefer to take a waiting stance with a view to reopening 50% of a long EUR/JPY position below 115.00. Consolidation in a 114 to 118 trading range is expected.

USD/CAD: We are keeping our short position USD/CAD at 1.5955 with a S/L at 1.6300. Price objective: around 1.5650.

AUD/USD: Same as last week. The failure to break 0.5280 keeps the Aussie under pressure. A move below the psychological barrier of 0.5000 would be very severe, putting into doubt all the bullish forecasts at the beginning of this year for a higher AUD. Price objective: 0.4850.

GBP/CHF: Same as last week. Extreme volatility will remain in this cross: 2.3850 is acting as major support now and 2.4450 acting as tough resistance. Only a clear break of either level would provoke the next movement of 200 points.