When all fundamental data point to a very weak recovery at best, and to a further dip at worst, there has to be some explanation for a 200+ rally on the DJIA on the very day (Monday) that negative leading indicators were released. Perhaps it is just that equity investors will not let go of their unreal expectations developed during the dot.com bubble. Short covering is also playing a role. More credible to us, however, is the hypothesis of a "Task Force" ready to intervene on certain signals from the Administration, especially on Friday afternoons a few minutes before the end of trading, and when publication of discouraging data might be expected to pull markets down.

Be that as it may, our task is not to foresee short-term movements in the stock market, but to gauge what is happening in the real economy to deduce the likely impact on fixed-income instruments. What we see at present only reinforces our forebodings of the last two years:

• A credit crunch is underway. Banks are reining in their lending, while bond markets have lifted spreads to levels where corporate borrowing has become expensive enough to put off even borrowers who could do something useful with extra cash
• A regulatory mood in the USA that will pass the FASB proposal to put securitised (off-balance sheet) debt back on the balance sheet. Good idea in itself or not, it will certainly make many balance sheets, especially banks', look sick, reinforcing the emerging credit crunch
• The profitability of US corporations is falling so fast that average PEs have risen and are continuing to rise since the bubble burst
• Household debt is so high that there is no room for interest rate increases should inflation become a threat (in fact, the only real threat is that of war with Iraq - already affecting the oil markets)
• The benign disinflation of recent years, attributed to increased productivity, is very close to becoming deflation, as demand lags production capacity and unemployment remains high since productivity removes the incentive to hire.
• The internal deficit of the USA is now approaching the unsustainable levels of its external deficit.

Outside the USA, but very much subject to malign influence from the USA in the person of Paul O'Neill, are a series of Latin American countries from which every commercial lender and investor wishes to withdraw. Europe now has billions of euros worth of rebuilding to be done after the floods (which will, at least, revive the building industry), and Japan remains totally unreformed and dependent on exports for demand growth.

Healthy economies can be found in the UK (subject to the ever-present threat of a housing bust), in Asia, and in Russia and other ex-Soviet states. Our relative admiration of the American entrepreneurial economy is tempered by our belief that the world is too much in economic awe of the USA. Europe alone seems unable to break the dependency, but with Russia and China on board for an open and free-trade world economy, a more balanced future begins to look perfectly possible.

Subject, of course, to the whole world not dividing into Islam vs. the West, a very present danger while the USA seems determined to bypass the UN in its dealings with Iraq, and still shows a total lack of resolution on the Middle East conflict.

Putting war risk aside for the moment, we see slow growth, low inflation, low Government interest rates, a weakening dollar, poor returns on equities, grave risks in corporate bonds and in Latin American debt -- all of which have been themes of this Weekly for more than two years - not only unfolding before our eyes, but coming with a greater downside risk. Low inflation may become deflation; credit tightness a real squeeze; rescheduling full default.

We shall, however, finish on a positive note. The lower dollar has led to marginally increased US exports. Despite wilful irresponsibility by the Bush Administration, market forces could yet bring about the US economic rebalancing that the whole world needs so much.

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

Weak leading indicators out of the US clearly show that the recovery is very likely going to be weaker than markets expected. Oil prices at around US 30.- are not justified in the current economic environment, but markets are still fearful of a US intervention in Iraq taking place fairly soon. In Europe, the flood catastrophe and growing deficits do not help to maintain optimism, either.

Japan's export industry has benefited the most from the modest recovery in the US and Europe, but might have more trouble in the months ahead with the continued delay in structural reforms and risk of further downgrading of Government debt. Liquidity remains thin during the holiday period, and further consolidation in a sideway market is the most likely outcome.

EUR/USD: Only a clear break of 0.9925/50 area might lead again to a challenge of parity, with 1.0050 and 1.0130 as next resistances. Downside support is at 0.9750, 0.9720, 0.9650 and 0.9550 (the short term range: 0.9650 to 0.9950).

USD/CHF: The US unit looks well supported in the 1.4850/1.4930 area, and topside resistance are 1.5050, 1,5120 1,5180 and 1.5250

USD/JPY: We still believe that any excessive JPY strength should be used to build up a long USD/JPY position. The 116.50-117.00 area should prove to be well supported, while topside resistances are at 118.80, 119.30 and 120.10.

EUR/JPY: Support is 115.50, 115.20 and 114.80, and topside resistance at 116.20, 116.80 117.50. The strategy is to buy on EUR/JPY dips.

USD/CAD: Key support is at 1.5480. If broken, 1.5350 will be the downside target, while topside resistance is at 1.5730, 1.5780 and 1.5850. A good strategy is to sell USD and again buy CAD in the 1.5850 to 1.6000 area.

AUD/USD: Support remains strong at 0.5365, with 0.5480/0.5510 acting as tough resistance. If broken, 0.5550, 0.5630 will be the next targets on the topside.