Weekly Wrap-Up May 17-21, 1999

Bond markets moved sharply lower on a relief rally which developed after the Federal Reserve Open Market Committee meeting. The Fed left rates unchanged, but shifted to a tightening bias for monetary conditions. This tips the scale decidedly in favour of the next Fed move in interest rates being higher. While many may believe that this would be bad for the bond market, in fact the reverse is true. By announcing a tightening bias, holders of long bonds believe that the Fed will be poised to react to any signs of inflation, thereby preserving the value of the bonds' cash flows. However, the front end of the curve, sold off substantially, pricing in a 50 basis point increase in interest rates. Equities were not as enthusiastic over the move to a tightening bias by the Fed. Concerns that higher interest rates would impact corporate earnings lead to a sell-off as the week progressed. High techs, internet stocks, financials and commodity stocks all felt the negative market tone. Some rotation out of high techs/internet stocks and into small caps and utilities seems to be occurring.

The North American bond markets moved sharply lower on a relief rally which developed after the Federal Reserve Open Market Committee meeting. The Fed left rates unchanged, but shifted to a tightening bias for monetary conditions. This tips the scale decidedly in favour of the next Fed move in interest rates being higher. While many may believe that this would be bad for the bond market, in fact the reverse is true. By announcing a tightening bias, holders of long bonds believe that the Fed will be poised to react to any signs of inflation, thereby preserving the value of the bonds' cash flows. However, the front end of the curve, sold off substantially, pricing in a 50 basis point increase in interest rates.

On the international scene Japan reported a drop in the trade surplus, indicating that the consumer may be re-emerging. If this is true, there should be a devaluation of the Yen, a subsequent decrease in imports, and increase in exports, and a revival of the domestic economy. A further sign that the Japanese may be dealing with their ailing economy is the reported 0.7% drop in economic capacity. This is the largest drop in capacity registered since statistics have been gathered in 1955. This is the first indication that the business community is coming to grips with Japan's excess industrial capacity.

Singapore reported that GDP rose 1.2% for the first quarter of 1999. This is a positive sign for the tepid recovery being posted by the southeast Asian economies. Along the same lines, China reported that it believed that GDP for the first half of 1999 would top 8.2%. However, the statistics coming out of Beijing are questionable due to the lack of economic transparency within the country. So GDP growth of 8.2% may be real, or not.

On the economic front several data releases came this week. In the US, housing starts dropped a larger than expected 10.1%, month-over-month in April, for the third monthly decline; the trade deficit rose for to a record high $US 19.7 billion from $US 19.1 billion. In Canada, retail sales rose 1.1%, ex-autos up 1.0% in April; the trade surplus rose to $CDA 2.6 billion in March from $CDA 2.5 billion; CPI rose 0.5%, +0.3% ex-food and energy, on month-over-month basis in April, up 1.7% headline and +1.4% core on a year-over-year basis.

The long end of the bond market responded well to the announced tightening bias of the Federal Reserve Board's Open Market Committee. After suffering significantly from supply and concerns about possible Fed actions over the last several weeks, the actual news helped long bonds. A short covering rally combined with some genuine investor buying helped push the bond market yields lower. In Canada, the 30 year long bond shed 9 basis points to close the week at a yield of 5.59%. While in the US, the US Treasury 30 year long bond closed the week 14 basis points to the good at 5.77%. (A basis point is 1/100th of a percent.)

The North American equity markets were not as enthusiastic over the move to a tightening bias by the Fed. Concerns that higher interest rates would impact corporate earnings lead to a sell-off as the week progressed. High techs, internet stocks, financials and commodity stocks all felt the negative market tone. Some rotation out of high techs/internet stocks and into small caps and utilities seems to be occurring.

The TSE was the star of the week despite weaker oil & gas prices, and a continued meltdown in gold prices. Bullion dropped another 0.87% to close the week at $US 273.10, down over 5% year-to-date. Cheap and getting cheaper as the store of value moves into $US and the Euro. The Toronto exchange posted a 1.15% gain, to close 79.47 points higher at 6,965.97. The DJIA lost 84.04 points to close the week down 0.77% at 10,829.28. The S&P500 lost 0.56%, while the Nasdaq lost 0.31%. The markets feel week, with little volume or investor conviction.

Next week brings a holiday shortened session in Canada, and most of Europe. The Victoria Day holiday, Monday, will mean the dealers in Canada have one less day to develop a book for the re-opening of the Government of Canada 5 year, in a $CDA 2.75 billion auction. Economic data on the week includes industrial production and raw materials prices in Canada, together with existing home sales, durable goods, GDP, personal income and consumption and the Chicago Purchasing Managers Index. Economic data is re-emerging as the key to market sentiment. Good trading.

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