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Weekly Wrap-UpJanuary 20-24, 2000 |
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Weekly Wrap-UpJanuary 20-24, 2000 |
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The North American bond market posted an impressive rally this week. Technical conditions, thin markets and sagging equity markets all contributed to the performance. This week saw the first sustained rally in US and Canadian fixed income securities in the long bear market we have seen. This sets up for a sell off in the bond market should investors not perceive the Federal Reserve Board as being pro-active at the February 1-2, confab.
On the commodity front, the Bank of England was in the market with another of its 25 tonne auctions of gold reserves. The auction went orderly, with a modicum of price concession to get it done. Real news came in the form of the Dutch Central Bank selling 23 tonnes of it's gold reserves. The Dutch Central Bank intends to sell 100 tonnes of gold, in total, by September, 2000.
The yield curve in the US played some interesting games this week. After being inverted 10 years to 30 years, the curve inverted further from 2 years out to 30 years. There have been three inversions of this nature over the past 21 years, all of which proceeded recessions. The first occurred in September of 1979; 4 months later in January of 1980 a recession began. The second occurrence was September 1980; 11 months later in July 1981 a recession ensued. The final 2-30 yield curve inversion in the US was August 1989; 11 months later in July of 1990 the last recession began. Past performance is no guarantee of future performance, but it is interesting to think about.
The Federal Reserve Board is meeting for a two day discussion on US monetary condition February 1-2. It is widely expected that the Fed will raise short-term interest rates 25 basis points and that the Bank of Canada will follow with a similar move. The last time the Federal Reserve Broad was in rate increase mode was February 1994 through to February of 1995. During this period the Fed raised rates seven times for a total of 300 basis points. Taking the three interest rate increases made in 1999 to remove the liquidity provided to rescue Long-Term Capital Management, the Fed has increased rates 75 basis points so far. Given the strength of the US economy there is a lot more room for the Fed to move more than the 50 basis point total tightening currently priced into the market. (1994-95 Fed Action: Feb. 94 - +25; Mar. - +25; Apr. - +25; May - +50; Aug. - +50; Nov. - +75; Feb. 95 - +25.)
Economic data released this week continues to show a hot economy on both sides of the border, with some concern over price stability. In Canada. raw material prices rose 3.6% month-over-month in December, with the yearly number rising 33.9%. Oil and gas as a component of the raw material price index rose 142.9% over the year. In the US, consumer confidence rose to 144.7 from 141.7, the highest reading in 32 years; durable goods orders rose 4.1% in December; fourth quarter GDP rose 5.8% annualized; the price deflator rose 2.0%; consumer spending rose 5.3% and government spending rose 8.4% during the quarter; employment cost index rose 1.1% in the fourth quarter, up 3.4% year-over-year. Employment benefits have risen at the fastest pace since 1993 as health insurance costs, paid leave, and bonuses all added to the cost of employment.
Despite all the strong economic data the bond markets managed to post a healthy rally over the week. Thin markets driven by a short squeeze in the long bond, coupled with a weak equity market all added to lower yields in the long-end of the yield curve. The 10 year section of the curve was hurt by supply as the Bank of Canada issued $CDA 2.8 billion of 10 year bonds. The US Treasury also helped the market with a long coupon pass, compounding the bid for long bonds.
The Government of Canada 30 year long bond rallied 16 basis points to close the week at a yield of 6.28%. The US Treasury 30 year long-bond shed 27 basis points over the week to yield 6.43%. The long end of the yield curve will need to see a very aggressive stance by the Federal Reserve Board in order to maintain the momentum seen in the past week. (A sell-off in equities wouldn't hurt either.)
The North American equity markets took it on the chin in a volatile week of trading. Exchanges on both sides of the border were down on the week shedding between 2.8% and 8.2% of their value. The tech laden Nasdaq wore the goat horns this week as companies with no cash flows were hurt by expectations that rising interest rates would make it more difficult for them to turn a profit in the future.
The big news on the week was the announcement by BCE that it would sell 95% of its stake in Nortel Networks, representing 38.7% of Nortel. This news lead to an arbitrage play which saw investors sell Nortel to buy BCE. Each BCE share is to be converted into 1 new BCE share and 0.78 of a Nortel share. The strategy, designed to unlock hidden value in BCE, has already done that to a certain extent as sales of Nortel equate to buys in BCE.
The TSE was the best of the worst this week. The Toronto Exchange lost 244.51 points, or 2.83%, to close at 8390.40. The DJIA shed 513.34 points to close at 10,738.37, down 4.56%. The S&P500 closed at 1360.13, down 5.63%. The Nasdaq posted its largest weekly loss since the Russian melt-down of August, 1998. The Nasdaq shed 348.33 points, or 8.22%, to close the week at 3887.07. The up coming interest rate hikes by the Federal Reserve Board in the US, and the Bank of Canada north of the border, will do little for the equity markets. If the Fed is not overly aggressive in its tightening cycle, the equity markets could hang in.
Next week brings a host of economic data in both Canada and the US, with the ever popular non-farm payrolls released Friday in the US. Adding to the excitement is the two day Federal reserve Board meeting February 1-2, to discuss monetary policy. A 25 basis point tightening in both the US and Canada is expected. Good trading.
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