This has been a week in which the policy of the US Government to keep the consumer spending has borne the fruit of both increased consumer spending and renewed stock market bullishness. Just as we thought the pigeons (of which we spoke last week) were landing as they came home to roost, they have suddenly been chased away again. The current account deficit, very high PEs, an over-valued dollar, the growing internal budget deficit, spare industrial production capacity, loss of corporate pricing power, uncertainties over pension funds, are all "pigeons" flying around, but which have to land one day. Last week the market's expectation was that the Fed would not dare raise rates until late in the year; this week August has now been earmarked for a first move upward. Overall, we remain very cautious about the recovery: we see the fundamentals as so anaemic that the Fed cannot move its rate up without undermining GDP expansion. We therefore believe our call to bar-bell in dollars and euros was basically correct, if a little early.

The strength of the dollar is both a problem and a possible solution. If the dollar continues to fall, some of the imbalances of the US economy and the world's could be reduced. If it stays high, continued denial will still rule. It is rather like the world being on an enjoyable drug trip. It is easier to sell goods to the USA than it is to develop one's own domestic economy. Never mind that the USA, a notorious debtor (by far the world's biggest), is forever increasing its indebtedness. The worst offender for US-dependency is, of course, Japan. Every time the USA (and, in fairness, some Asian countries) start sucking in additional imports from Japan, the Japanese trade surplus balloons, the yen strengthens and the very need for reform weakens (we were tempted to write "the urgency for reform dissipates", but the concept of urgency seems unheard of in Japanese political circles). Japan will not let its pigeons home to roost either!

Euroland continues to suffer from its self-imposed straitjackets of a 2% inflation ceiling and the Stability Pact (we see the former as the more negative). The ECB frets about having to raise interest rates, just when the economy can least afford it. France makes noises about reducing taxation to boost the economy, but Germany promptly says, "You can't do that!" It really is not very edifying. If the high-taxation parties stay in power this year in the largest Euroland economies, the opportunity to "set the market free" will again have been missed.

We see a grain of optimism, even though based on an unexpected phenomenon. The Dutch elections, with their protest vote and move to the right, represent a serious warning to politicians that they must listen to the people's concerns. In addition, the Dutch are turning away from their traditional social-market economics. In both regards, their traditional trailblazing role for Europe is one we see as positive for us all.

The euphoria created by this week's US consumer spending takes people's minds off other vital issues like those concerning financial reporting. It does not help the overall image of financial reporting that, faced with Congress refusing to lift the borrowing limits of the US Government, the Bush/O'Neill team simply go into dodgy inter-account borrowing to be able to keep spending. This, while the Andersen trial and bank inquiries quietly continue. The latest ramblings of the International Accounting Standards Board look awfully like a weakening of position. However, the IASB are at least claiming that they are sticking to the primacy of principles over prescriptive rules (GAAP stand accused of the opposite).

Recently we have expressed concerns about the overvaluation of emerging market sovereign bonds. A degree of contagion is spreading as Argentina's economy worsens. Uruguay has seen further downgrading and spreads have widened, especially on Brazil, where there is much nervousness on the standing in the opinion polls of Luiz Inacio Lula da Silva, the populist candidate of the Workers' Party (PT). In fact, only Russia seems currently insulated against spreading doubts on emerging markets. There will come a time when emerging market sovereign bonds are oversold, but currently we would see them as still overbought.

Recommended average maturity for bonds in each currency
Bar-bell in dollars and euros, lengthen in Swiss Francs, but no change yet in Sterling.

The negative sentiment towards the US unit remains and the extreme volatility in the US equity markets does not help inspire confidence. Market participants are starting to be underweight in US stocks, and major banks worldwide have begun to change their FX-forecasts, looking for a higher euro. However, the fact is that economic recovery in the USA is under way, and their "mixed" numbers are far above anything in the EU. France wants to cut taxes, Germany is still affected by strikes and the EU commission urges budget prudence, eyeing Portugal, Italy, Germany and France.

As we stated last week, consolidation is likely first before further euro gains might be seen.

EUR/USD: It looks that the rally in the euro is running out of steam. A break of 0.9180 to test 0.9250 is needed, followed by 0.9340. Any loss of 0.8990 would be catastrophic and open the door for 0.8930, 0.8880 and 0.8840.

USD/CHF: Once again, movements below 1.6000 remained short lived and the strong CHF could not achieve any additional gains, testing 1.5880 only once. Our first target of 1.6150 has been achieved, and 1.6250 and 1.6330 are next. Only a break of 1.5780 would put that scenario into doubt and lead to a direct target of 1.5650.

USD/JPY: We still see continued consolidation in a range of 126.50 to 130.00. Japan is again achieving very impressive surpluses with its export industry thriving (nothing has changed domestically). Exporters are continuing to sell USD in the upper 129.00ish levels, capping the dollar below 130.

EUR/JPY: Same comment: the major support zone remains around 114.50/80 and is holding for the time being. The upside is capped by 116.50, 117.20 and 117.80. Any sustained break of 114.50 would see this cross immediately down to 113.00.

USD/CAD: Some consolidation is likely in a 1.5550 to 1.5780 range. We might reconsider re-establishing again a short USD/CAD position in the high 1.5700s.

AUD/USD: The rally in the Aussie has continued and even took out our resistance level at 0.5450, to test a high of nearly 0.5500. Despite our remaining positive on the Aussie and looking for higher levels medium term (0.5650), we still expect some consolidation first and think that there will be a better buying opportunity around the 0.5350 area.

GBP/CHF: Sterling continues to be under pressure, and 2.3550 is acting now as a very strong resistance. Downside targets are 2.3250, 2.3160 and 2.3000. Consolidation is likely here first, as well