Weekly Bond Review April 25, 2004

RATES: The bond market traded to new lows this week, mainly as a result of a change in the tone of Fedspeak. Chairman Greenspan’s testimony in front of the Joint Economic Committee was surprisingly hawkish relative to recent commentary by Fed officials. Stronger than expected economic data just added further pressure to rising rates. The bond market is in a negative mode and it seems like the path of least resistance is still lower in price, higher in yield. The next 2 weeks will witness choppy trading as the market deals with a truckload of economic releases as well as the FOMC Meeting on Tuesday, May 4.

So the big question after the past week is where does the Fed stand now?? Sounded to me like not only the Chairman but also some of the other Fed speakers last week have changed their tune from overly accommodative to preparing the market for a rate hike or 10 in the not too distant future. It seems curious that just a couple of months ago Mr. Greenspan was on the tape recommending short term, adjustable rate mortgages, only to turn around last week and leave the folks that listened to him scrambling to lock in longer term as rates might start to rise. In past issues I have discussed the reasons why I feel that the Fed should be in no hurry to raise rates. To me the big picture has not changed in spite of some stronger than expected economic data, including a questionable employment report. The recent strong data has been mostly old news that was reported for the period prior to rates rising 80 basis points on the US 10 year note. While I still believe that fundamentals are bond friendly going forward, in light of the new information released this past week, I am going to allow that the Fed might actually raise rates sooner than I previously expected. I am still not sure why, but depending on the data going forward, it is a distinct possibility. With the output gap still wide open and the labour market soft, the only reason I see why the Fed would want to tighten is to remove the label of being overly accommodative while the economy is humming along at a 4-5% clip. The next question is where does the Fed feel that a balanced Fed Funds rate should be in the present environment. I have seen estimates based on the Taylor rule as low as 1.25% and as high as 4.5%. Take your pick. Mine would be closer to the lower end of the spectrum.

The sentiment in the portfolio manager camp is staying at excessively bearish. The leveraged crowd is still long the carry trade. Seasonals for bonds are increasingly deteriorating as we head into the month end. The mortgage space is going to become an increasing concern going forward. Mortgage defaults are at all time highs, rates are rising, the home prices look toppy. Credit concerns are not an issue at this time but they soon will be increasing.

US long bond futures closed the week at 107-15 and the yield on the US 10 year bond was 4.46%. 4.5% support is still hanging in there. We are getting into oversold territory, and the trade will be choppy subject to news for the next week or three. Canadian bonds outperformed the US over the past week. Canada – US 10 year spread closed at 22, in another 7 basis points for the week. While I still think that the belly vs wings makes the most sense, the US-Canada spread trade recommendation has worked the best over the past month. BA futures are telling us that the BOC will start raising rates soon. I beg to disagree and will be looking to buy the front end on dips here. March05 BA futures under 97 is a bargain. The belly of the Canadian curve stabilized and actually outperformed slightly last week. It is still possible to sell 2005 and 2033 Canada bonds and buy a 2011 issue and pick up well in excess of 100 basis points. To put it in a different perspective, the yield enhancement is in excess of 30% before rolldown is considered. This trade makes a ton of sense and if it widens more, one just adds to it. It is the best/safest trade idea I have.

PROVINCIAL CREDITS: Provies slightly wider in the long end. I feel much more comfortable with provincial credits than corporates. Recommend overweight in BC, Saskie and Manitoba credits.

CORPORATES: Corporate bonds narrowed a tad. Long TransCanada Pipeline bonds are in 2 to 110, while long Ontario bonds widened .5 to 45. A starter short in TRAPs was recommended at 102 back in February.

BOTTOM LINE: Bonds are no longer in an up trend. Breaking through 4.27% opened the door to 4.5% and perhaps higher in yield. Neutral duration is recommended at this point. This is a good time to add to and max out a long position in the belly of the curve. The overweight recommendation for the belly is by far the lowest risk/highest reward trade that a portfolio manager can employ at this point. The starter short in the long end of the corporate sector is still advised. Long Canada vs US 10 years still makes sense as well.

GENERAL COMMENTS: Silver is off close to 30% from its high set 3 short weeks ago.

Levente Mady Resolution Capital 604 232 0344 leventem@resolutioncapital.ca

The information herein is believed by Resolution Capital Inc.(RCI) to be reliable and has been obtained from sources believed to be reliable, but RCI makes no representation as to the accuracy or completeness of such information. This report is provided for informational purposes and is intended for knowledgeable institutional investors only, and is not to be construed as an offer or solicitation to buy or sell any financial instruments or to participate in any particular trading strategy.

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