The month is closing with a mixture of contradictory signals about the US economy, matched only by the uncertainty of an attack on Iraq. For equity investors there is a sense of hope in seeing a monthly gain after five months of declines, but heavily tempered by the data on diminishing consumer confidence.

The volatility of the stock market has its counterpart in bonds. Any increased optimism about stocks is washing through to reduced spreads on both corporate and emerging market bonds. Three weeks ago, we experienced a classic case of not being able to find a decent bid, even for small size in an "A" corporate bond eight months from maturity. Then, one week later, we were pestered by the very banks who would not bid, to buy that same bond at a considerably higher price. This illustrates the "short-termism" that investors have to live with, as well as the fear of committing capital by highly paid bankers acting increasingly like lemmings and showing no confidence in their credit research.

The current focus on data issued daily and on the performance of the DJIA and Nasdaq has turned the whole world into day traders. There are, of course, economists making analyses of the fundamentals and stepping back from the day-to-day fluctuations. They tend to take the same line that we have been following for so long: slow recovery, poor profits, low inflation and interest rates and, now, a risk of deflation. Even Business Week is adopting this line by stating that the 2001 recession was not severe enough to allow anything but a "wimpy recovery". That is like saying that, without rebalancing, the patient is still poorly.

There has been a slight shift in the economic debate this last month. Low interest rates, coupled with disenchantment with stocks, have pushed up house prices in the USA and expanded sales of both existing and new homes. It is estimated that stock price falls since the peak have generated $ 4.8 trillion of portfolio losses, while the gain in house values over the same 2Ѕ years amounts to $ 1.7 trillion. The latter figure, although smaller than the first, is said to affect a far greater number of the population than the stock market losses. This argument is based on the much greater proportion of the US population who are home owners vs. significant stockholders. Its strength is, however, weakened by the impact of stock falls on 401k's (the US individual pension fund system). We therefore find it difficult to suppose that consumer confidence and spending can be supported much longer by house prices, even if there is no "bubble burst" in house prices as such. This very morning, one more piece of contradictory news came in to us via a private contact in the USA. He told us house prices had started declining. If true, it is "hello, negative equity!", along with "hello, nervous bank lenders."

Whatever risk the USA is creating for itself in inflating house prices, the risk in the UK has to be higher still. Thus, even our "enfant chйri" (when comes to economic management) is in danger. The rest of the European Union just cannot get its act together to create an entrepreneurial society. We concluded years ago that Japan is hopelessly enmeshed in deflation, and is now politically incapable of reform.

In recent weeks we have often alluded to the extraordinary achievement of the Bush Administration in turning the large inherited internal surplus into an equally large deficit, almost as big as the external deficit. Not only does the Administration seem no more worried about this than it is about world views on Iraq, but it is making a bad situation worse. The figure of $ 157 billion deficit for the year ending September 30 can only grow as tax receipts drop, and Government spending increases. The current Administration may be expected to go down as the most economically irresponsible ever, never mind its international politics!

The US internal deficit must negatively affect the economy and bond markets in due time. Obviously the Treasury will be issuing a lot more bonds. It has not officially said as much, but we suspect that the previous Administration's policy of not issuing (and even buying back) long-dated Treasuries will be quietly dropped. Presently, the Treasury can "get away" with borrowing short, as the Fed has flooded banks with liquidity that they cannot or do not want to lend. However, such a situation is inherently unstable. Should the recovery strengthen, the Administration will be in competition with the private sector for borrowed funds, and that would mean higher interest rates, which in turn make a strong recovery impossible. Our view is that the deflation risk is still present, that interest rates cannot move up, and that fixed-income investors must stay at long average maturities.

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

Mixed economic figures out of the USA, growth expectations revised down again in Europe and shrinking trade surpluses for Japan, all point in the direction that the long awaited world-wide economic recovery is most probably postponed until the end of this year at the earliest. We hope that the forex market is going to become more lively after the summer recess and the forthcoming long US Labor Day weekend.

EUR/USD: Only a clear break of 0.9925/50 or 0.9610/30 might provoke a movement of at least 150 to 200 points. This pair is still in a consolidation mode.

USD/CHF: The consolidation range of 1.4850 to 1.5250 is prevailing. Only a clear break of either of these levels could bring some fresh opportunities with a movement of easily 150 to 200 pts.

USD/JPY: Same comment: 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, and topside resistances are at 118.80, 119.30 and 120.10.

EUR/JPY: Same comment: supports are 115.50, 115.20 and 114.80, and topside resistance at 116.20, 116.80 and 117.50, with a "buy on dips" strategy of EUR/JPY.

USD/CAD: 1.5480 remains the key support, expected to move to 1.5350 if broken. Topside resistance is 1.5650, 1.5730 and 1.5780, suggesting a strategy of selling USD and buy CAD again in the 1.5850 to 1.6000 area

AUD/USD: The resistance at 0.5480 has been broken and 0.5560 has been tested so far. As long as the rate stays above 0.5480, further upside attempts might be possible with 0.5580, 0.5610 and 0.5670 acting as tough resistances.