For fixed-income investors the starting questions are "whither inflation?" and "whither exchange rates?' The other issues like corporate spreads and emerging market risks are important, but always follow on from these starting questions.

Let us deal with the exchange rate issue first. Our friends at GNI point out that the USD/EUR resistance was broken overnight and the forex market has an appetite for a higher euro. Our analysis of the fundamentals has been pointing in this direction since capital flows to the USA fell drastically at the beginning 2002. US Administration policy seems quietly to have slipped from "a strong dollar" to "let the dollar fall, it will help exports". Thus, there is something in US economic policy with which we agree, even if it is unspoken! A weaker USD will help exports and is needed to rebalance the world economy.

At this point European industry and governments must be saying "enough of a good thing" as the euro continues to strengthen in spite of dismal GDP growth. However, three self-reinforcing trends can be identified that suggest the trend will not stop just yet:

• Reserves in many countries, especially those with a growing surplus like Russia and China, are being shifted more in favour of the euro
• The euro is making inroads, as yet modest but not to be ignored, into the dollar's dominant role as currency for international trade
• International capital flows, disenchanted with returns in the USA, are looking for alternative homes, and Euroland is one of the destinations.

In addition, but we cannot call this "self-reinforcing", the euro zone has a net current surplus. As Japan has demonstrated, it is difficult to hold a currency down with a current external surplus. Japan also reminds us that strong currencies may not help economic recovery. Indeed, the strong euro is not healthy for the European economy; it just looks unavoidable as the reverse side of dollar weakness.

The inflation part of the starting question is linked to the exchange rate part. A first conclusion is that the deflationary environment in Europe will persist, as a stronger currency means lower costs but no chance of raising prices. The ECB can and eventually will cut rates again. For the USA, however, no such "obvious" conclusion jumps to mind:

• On the one hand, employment costs have risen sharply in the USA (1.3% in the first quarter, the fastest growth since 1990), even as unemployment continues to grow, and the American consumer is back on a new spending spree.
• On the other, unused production capacity and the pricing pressure from China (products and outsourcing) are still there.

In the end, the US economy is damned one way or the other:

A. Should it take off, inflation will appear and the interest rate increase will quickly spoil the party.
B. Should it remain stalled, the Fed will return to the policy of further cuts on the overnight interest rate, with the Treasury issuing up to but not beyond ten years. This would imply steepness at the short end, then relative flatness after five years, implying that longer maturities are to be preferred.

All we can do is maintain our "watchlist ten years", for which way the US economy will now go is unclear, even though our instincts are towards scenario "B".

The success of Brazil in its new issue is welcome, and the resultant market conclusion that the risk of default is over. The relative slow motion of developments in emerging markets has been epitomised by Lula's impact: first "maybe it won't be so bad", then "he is being remarkably responsible" to "it looks like he has done it", over a period of several months.

Sadly, a slow motion division in politics and defence, with likely economic repercussions, may be unfolding in Europe. The USA is a difficult ally, but ally it is. Are new defence structures really needed? Or credible?

Recommended average maturity for bonds in each currency

We maintain our recommendation for maturities in euro to average ten years.

EUR/USD: With the psychological barrier at 1.1000 breaking and the outstanding high at 1.1085, a large number of stop losses have been triggered, and 1.1150 has so far been tested. The next resistance is at 1.1220, 1.1280 and 1.1350. A move below 1.1000 and, more importantly, at 1.0940 might be the signal for a deeper correction.

USD/CHF: After the critical support at 1.3780 was broken, our target at 1.3550 was exactly reached. The next big support is 1.3480, with a weekly close targeting 1.3280. We are still very hesitant for an additional down move and would rather say that the present zone represents a buying opportunity.

USD/JPY: There is strong support below 118.00.-. The upside is at 120.80 and 121.10, with a weekly close above these levels looking for 122.50. A trading range between 118.-. and 121.30 looks likely.

EUR/JPY: 131.50 is acting as the major support in this cross. Our objective around 133.50 has nearly been reached, with the next levels at 134.20 and 135.--. A break at 131.50 would open the door for at least 130.- .

GBP/USD: The key level at 1.5850 has broken and opened the door for 1.6000. As long as the rate stays above this, next big levels are 1.6050, 1.6130 and 1.6250.

USD/CAD: The CAD remains one of the market's favourite. Toronto, with its SARS cases, was used as an excuse to push this currency pair in the direction of 1.4700, but the move was short lived. The key level at 1.4550 again gave away, and as long as the rate stays below this level, 1.4350 is still the next big target to be once again in sight.

AUD/USD: As long as the rate stays above the 0.6000 area, the Aussie remains buoyant. Any break would provoke a move down to at least 0.5850. The upside target of 0.6250 has nearly been seen. The next levels are 0.6280 and 0.6350.