Immediately after the September 11 attacks we were looking for some silver linings in the clouds, and we found hope that relations between the West and Russia (and Iran) would improve, and that many of the processes already underway to correct the post dot.com bubble would be accelerated. These things have come to pass, more quickly that we expected, and with some big bonuses. The "new" Russian connection is of key strategic importance, resulting in the taming of OPEC's power to squeeze the world every time its economy looks like doing well. The USA now feels able to push seriously and even dictate the Palestinian/Israeli "peace process" in the direction of a Palestinian State, with Israel withdrawing from the Occupied Territories (it will be interesting to see if Colin Powell and the UN dare use that appellation). The USA has cut its rates even faster than it otherwise could have, flooding the money supply while disinflation reigns. The liquidity and general "feel good" factors, such as the Taleban disintegrating, have led to a major recovery of the stock markets. Bonds have fallen in value, giving back between a quarter and a third of their gains since August 15, when we recommended lengthening.

To some extent fixed-income specialists are bound to be somewhat sceptical about stock markets, so readers will bear with us while we spell out our reasons for caution about the current bull stock market:

• The hard data on industrial production and employment are still moving down
• Company earnings are still declining (and that includes forecasts for the current period)
• Corporations still have a long way to work through their excess inventories and over-capacity
• Consumer spending in October was so high only because of special car financing deals
• The US GDP growth of 4.2% in 1999 has fallen to 1.1% in 2001 and is forecast to fall still further to 0.7% for 2002 (source www.economy.com)

Can profits grow when underlying GDP growth is so anaemic? Can these PE ratios be sustained? PEs are now back at levels (almost 30 on the DJIA) last seen when we doubters were all thinking the bubble had to burst. One view is that such PE levels can only be justified if earnings turn round and move forward. Another is that PEs have become less relevant (as they were for so long during Japan's long bubble). So much money, loath to accept the low yields of fixed-income instruments, prefers to seek potential for further rises in stock values.

While stock markets are undeniably bullish, bond markets are telling a mixed story. Admittedly, Treasuries have declined, while corporate bonds issues, especially convertibles, are highly sought after, with a lot of issuance. Yet, at the other end of the scale, in speculative grade bonds, default rates are approaching those of 91/92. Furthermore, the ratings agencies are downgrading far more corporate bonds than they are upgrading. Such direct contradictions of the corporate bond market and the equity market last occurred in 1991, when it turned out that bond pessimists were right.

While satisfied with getting the stock market on its feet, the Fed will still be looking for traction in the real economy. Since this has not yet been achieved, further cuts down to our expected low of 1.5% in the overnight target rate are almost certainly in the pipeline. Similar cuts may be expected in Europe, although rates will stay significantly higher in absolute terms than in the USA.

As the USA steers between the dangers of inflation from success of its economic policy and deflation from failure, we remain optimistic that success will be achieved, but not so quickly as most commentators are supposing (we see underlying recovery a year away, not a mere six months).

As we have indicated in our recent weekly comments, some of our clients have already been shortening. The time has indeed come for a general move from long to medium maturities. We are putting all major currencies at five years (which implies the greatest shortening for euros and Swiss Francs). Actually, this is not yet the drastic and rapid shortening that we may still have to recommend if traction is achieved. Rather it is an adjustment to reflect the changing shape of the yield curve.

Recommended average maturity for bonds in each currency
Begin to shorten, especially in euros.

No major volumes are to be found this short, Thanksgiving week. In the USA profit taking on stocks already started yesterday, and it will be seen what happens before the long weekend. This morning the Ifo October business climate showed that the ECB may be expected to cut interest rate by another half point. Also the BoE November minutes came out in line with expectations and showed strong endorsement of the last rate cut on the 8^th November.

EUR/USD: The single currency is moving in a broad range 0.8760/0.8890. With the strong recovery of the US stock markets the last two weeks, pressure has continued to push down the euro. For the week to come, we favour a test and a break of the bottom of the fork, with a first objective at 0.8710. Only a break of 0.8950 on the upside could oppose our bearish view.

USD/CHF: We are targeting 1.6770 medium term, followed by 1.6850. 1.6470 supports the greenback and an exaggeration up to 1.6350 is possible. On the upside, 1.6635 could slow down any change in the exchange rate.

USD/JPY: Tried twice to break 123.50 without success. Now the exchange rate should find support at 121.50 and once again try the break on the upside, which should open 124.25 and 125.30.

GBP/USD: A quiet, impressive move over the last two weeks. Sterling has now found support between 1.4115 and 1.4080. A correction in the direction of 1.4350 should appear. A break of 1.4080 should announce 1.3975.

EUR/JPY: Triangle formation. A clear break of 109.30 or 106.80 should show the next significant move.

USD/CAD: Keep the position short USD long CAD. Trading range 1.6050/1.5800. We are expecting a break of 1.5800, to target 1.5600 medium term.