Do you recall when markets were rising and the US economy overheating in 1998/99? Each time the FED raised interest rates, share prices fell back, only for them to continue their climb after a couple of days, when it dawned on investors that the rate hike was proof of how strong the economy was, or, at least, how strong the bullish sentiment was. Had the Fed cut rates on Tuesday, the reverse phenomenon would probably have occurred. However, since the Fed left rates on hold, the anticipatory rise in share prices promptly reversed. On such scarcely relevant and short-term data do markets gain or lose 1 or 2 percentage points in a day. Hardly rational analysis!

It is also hardly rational economic leadership when the best the US President can do is go on television to state that he "believes in America". Imagine for a moment if any European politician came out with "I believe in the UK (or France, or Germany or whatever)" as an argument to boost the stock markets. Unthinkable, thank goodness, is it not?

Markets are also rattled by the deadline for CEOs to swear to truthfulness in their accounts. Many cannot meet the deadline, and silence is not golden in these circumstances. We persist in our view that deceptive accounting is a symptom, not a cause of the present bear market. That is to be found in "unreality".

Corporate bond markets are not just showing volatility, but reflecting the growing unwillingness to lend, the emerging credit crunch and the absence of new issues as spreads balloon. It is a sign, if any more were needed, that financial market readjustment to reality is far from over.

One fine day, perhaps, playing games will cease and the USA will get on with what it is so good at: being: a dynamic, entrepreneurial and wealth creating society, where earning rather than "making" money predominates. The current trend to call in the old guard to replace flamboyant (and often devious) CEOs is heartily to be welcomed.

One fine day, also, we shall be able to write in this weekly, that European markets and economies are functioning without our obsession with the USA. Try as we may, it is difficult to feel enthused about the politics and economics of Europe. Francis Mer, the French Finance Minister, who has enough personal wealth and years of successful career behind him for independence and honesty, is a reformer. However, he is already encountering resistance very much like Koizumi in Japan.

Germany holds out the hope of a change to a reforming government. It is as near a certainty as politics can get that Schroeder, having himself told the German people to judge him on unemployment, should be thrown out on that very issue. Overall, the German elections will be the turning point of European recovery, if there is to be one.

The UK seems to have found a quite successful mix of enterprise and government, but the sooner the housing bubble deflates the better, in the long run. The headlines in the UK express shock that inflation had risen from 1.5% in June to 2% (per annum) in July. It is difficult to know what the fuss is all about, when the BoE target is 2.5%, and deflation is currently the greater risk to all economies.

Harvard economist, Ricardo Hausman, shares with us a belief that if Paul O'Neill is involved, a problem cannot be far away. Hausman rightly points out that if, first you say that handouts create moral hazard and the cash goes to Switzerland anyway (just how out-of-date can a man's views be?), and then you say that a country, in this case, Brazil, is really deserving of an IMF rescue, you just might make markets more confused than ever. Could it be that Mr. O'Neill is less interested in saving Brazil than in helping US banks rid themselves of Brazilian debt at the most favourable terms?

Our earlier warnings about the dangers of deflation remain valid, and leave us in no doubt that long-maturity Government bonds are the place to be.

Recommended average maturity for bonds in each currency
Stay long across the board, except in Sterling.

As expected, the Federal Reserve held interest rates steady yesterday, but warned that economic risks were now tilted toward weakness. According to a Reuters poll, it seems that now around 70% of market participants are expecting no further easing this year. We firmly believe, however, that it will depend on the US stock markets!

EUR/USD: The decision of the Fed not to ease monetary policy disappointed the market and put some pressure on the dollar. After 0.9890, seen this morning, a quick and clear break of 0.9925 is needed to reach 1.0050. A return to below 0.9775 would refute this bullish scenario.

USD/CHF: Last week, the greenback failed to find the strength to break 1.5150 and, as expected, returned to below 1.4950. The break of 1.4900 yesterday suggests that the old fork 1.4900/1.4600 is back. The next important support will be at 1.4725. 1.4925 is the key resistance.

USD/JPY: What a fall! Since the end of last week, the feeling was already a little negative on this pair, but the break of 118.60 actually put the exchange rate below 117.00. Technically 116.75 is the next support before 116.00, but we have to be careful about the BoJ being concerned by those levels. Resistance is at 118.00.

EUR/JPY: As envisaged, the break of 116.40 provoked a 100 bips movement. 115.00 has become an important key level and, with the BoJ watching carefully, we do not think that this level will be crossed. A return on 116.50 sounds more reasonable.

USD/CAD: The Canadian dollar is back on the low side. Key support is now at 1.5520 and a daily close below that level could bring the rate back down to 1.5350. Resistance is at 1.5675.

AUD/USD: 0.5425 is the next resistance before our 0.5500 target. Support is at 0.5365.