Weekly Wrap-Up August 3-7, 1998

Closing Numbers

The North American bond markets diverged this week, as the Canadian dollar continued to drop to new record lows, and the US market benefitted from the continuing flight to quality. In Canada, the 'Loonie' set record lows all week prompting the Bank of Canada to come to the defence. The Bank stepped into the foreign exchange markets in an effort to demonstrate to international and domestic investors that the currency deserves their confidence. Too little, too late? Some still believe that the Bank of Canada will have to raise short-term interest rates by as much as 100 basis points in order to bring investor confidence back. In the US, the continuing turmoil in the international economic forum fuels the flight to quality argument that many are using to put a spin on the action south of the border. This will suffice in an otherwise story-less week.

Canada is facing a crisis in confidence with respect to the currency. This, in turn, is putting pressure on all Canadian financial markets, as is witnessed by the activity in the Canadian bond market. There is a comparison which may be drawn here between the recent currency crush felt by Australia and the one being experienced by Canada. The Australian dollar was feeling the pain of having a resource based economy which exports primarily into Asia. The central bank in Australia defended the currency in the foreign exchange markets, but left interest rates unchanged. After a period of significant volatility the currency and the bond market settled down. The Bank of Canada should follow the same course, keeping in mind that it's foreign exchange reserves are only so deep, so only spend the bullet when markets are unruly.

The US market is stuck in a range trading mode, as there is little information coming out of the statiticians' that is not already fairly priced in the market. The momentum associated with the flight to quality trade is not as strong as it was six weeks ago, and the summer doldrums generally mean that investors have more important things to do, like vacation with their families.

The Canadian bond market continues to underperform the US market as investors push yields up through those in the US. The Canadian yield curve had traded at a premium to the US for months, however, this is coming to an end. By the end of the week, all maturities along the Canadian yield curve over their counterparts in the US, except the long bond. The long bond will fall next week. The Government of Canada 30 year bond closed the week at 5.62%, up 3 basis points on the week. The US 30 year Treasury bond fell 9 basis points on the week to close at 5.63%. The Canada/US long bond spread is -1 basis point after being at a narrow of -33 basis points only weeks ago.

Economic data released in North America continue to show that the economies are growing at a healthy pace, but slowing, with little sign of inflation.

In Canada, building permits for June were up 1.4%; help wanted index for July was +0.7%; labour income fell 0.2% in May, international reserves rose $CDA 2.55 billion to $CDA 22.52 billion, of note was the sale of 168,000 ounces of gold by the Bank of Canada in an effort to build the war chest to defend the Canadian dollar; Unemployment rate for July remained unchanged at 8.4%, with 6,300 full-time jobs and 20,300 part-time jobs created.

In the US, construction spending for June was up 1.7%; July's National Association of Purchasing Managers Index declined 0.5 to 49.1 (any reading below 50 is an indication of a slowing economy); leading indicators for June declined 0.2%; factory orders rose 0.1% in June; initial unemployment claims rose 307,000; non-farm payrolls advanced 66,000 to leave the unemployment rate unchanged at 4.5%

The North American equity markets experienced the roller coaster ride that is volatility. The Canadian markets continue to be tied to the fortunes of the Canadian dollar, and the potential for recovering demand out of Asia - slim to none. American markets are being dominated by the $US/Yen and the fundamentals of corporate earnings.

The TSE finished the week down 290.34 points, or 4.19%, in a holiday shortened session, at 6641.09. The DJIA posted a loss of 3.21%, or 285.27 points, to close at 8598.02. The S&P500 finished the week down 2.79%, while the Nasdaq closed off 1.37%. Look for the turmoil in the equity markets to continue as the summer rally is over, and the fundamentals of earnings, cashflows and market conditions for individual companies reassert themselves as important factors in the stock selection process.

The troubles in Asia are far from over. The political will to deal with the financial turmoil in Japan still has not emerged. In Japan this week it was reported that household spending declined 1% in June on a year-over-year basis. At that rate it is unlikely that the consumer is going to pull Japan and the rest of Asia out of its recession.

The dropping Japanese yen continuously brings about the spectre of China devaluing the yuan in an effort to have it's exports remain competitive on the international markets. If China devalues, then the whole of Asia will experience a relapse as the Asian flu takes hold in another round of financial and economic nausea.

Vietnam devalued its currency, Thailand pulled its proposed foreign investment guarantee plan to prop up the financial sector, and Indonesian economists called for the resignation of President Habbibi, or his adoption of sweeping economic reforms, in order to prevent the collapse of the Indonesian economy.

The Russian economy is being supported with the help of the IMF to such an extent that at the recent professional tennis tournament in Toronto, a spectator was over-heard commenting that a Russian tennis star was being sponsored by the IMF.

All this and Tigger too!!! Look for the markets to continue their volatile ride next week. The Canadian fixed income and equity markets should underperform the US markets as Canada's currency concerns and dependence on natural resource exports weighs heavy. The Bank of Canada is somewhat handcuffed, as the economic data indicates a slowing economy which could be pushed in to a contraction if interest rates are raised to defend the currency. The US market's big indicator this week will be non-farm productivity for the second quarter. Look for the number to keep pace with wage growth or the Fed may really move to a tightening bias. Good trading.

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