Weekly Wrap-Up February 22-26, 1999

The weighty words of Federal Reserve Board Chairman Alan Greenspan, and more supply in the bond markets forced rates higher over the week. Equity markets retreated as higher yields in the bond markets hurt expectations of future earnings for stocks.

The North American bond markets were hurt by a slightly hawkish speech by the Federal Reserve Board Chairman, continued strong economic data and new supply. A bearish tone from the previous week, and deteriorating technical conditions pushed yields higher on both sides of the border. No supportive words emerged from the G7 meeting over last weekend, which did little to help market conditions.

In his two day Humphrey-Hawkins testimony, Federal Reserve Chairman Alan Greenspan painted a picture of a robust US economy which could require the Fed to either cut interest rates to spur growth, and prevent a liquidity crisis; or raise interest rates to remove some of the stimulus and liquidity that the Fed added last Fall in order to prevent a collapse of the US financial system. Mr. Greenspan indicated that the US economy faces "considerable upside and downside risks".

The Fed Chairman identified four key risks which the US economy currently faces; i) tight labour markets; ii) high stock market valuations; iii) growing debt levels; iv) fragile foreign markets. With his concern over the stock market valuations focused on investors' current predisposition to incorporate both robust profit expectations and low compensation for risk into market prices.

The Bank of Canada released its economic prognostications for the near-term this week. Governor Thiessen's release had little impact on the market, as his forecast read pretty much as one might expect. The Canadian economy is doing better, needs to improve its productivity, and should remain in a healthy steady state, provided the US economy continues on its robust growth path.

The G7 meeting over the weekend had little to offer in the way of solutions to the current economic slowdowns in both Asia and Europe. Discussions focusing on establishing a foreign exchange peg went nowhere. Japan was told to increase liquidity to foster domestic growth, and help put the region back on stable economic ground. The big issue in Japan continues to be the under-capitalization of the financial sector. Japanese finance officials helped the cause of exporters by talking down the value of the Yen relative to the $US. In the end the G7 meeting provided a good photo op. with little substance.

On the international scene little influenced the markets in the way of economic news. The only noteworthy incident was the re-appearance of the central bank of Brazil in the FX markets. The Brazilian currency, the real, required a little support, and the bank was in buying reals and selling $US. A drop in the bucket, but good for psychological reasons.

On the economic front this week, a host of data were released indicating a strong North American economy with little evidence of inflation anywhere on the radar screens. In the US, consumer confidence rose 3.2 to 132.1; durable goods orders rose 3.9%, mainly chunky aircraft and auto orders; first-time jobless claims dropped to 293,000; existing home sales rose; revised fourth quarter GDP was increased 0.5% to 6.1%; price deflator was revised down 0.1% to 0.7% (the lowest level since the end of the Second World War). In Canada, the industrial producers price index dropped 0.3%; the composite index rose 0.4%; retail sales dropped 0.3% in December. The December decline in retail sales in Canada has been blamed almost entirely on clothing, as warmer than normal temperatures had few consumers thinking of winter apparel.

Supply came in the Canadian bond market with $CDA 2.5 billion 5 year bonds auctioned, and well received. However, the Government of Canada 30 year long bond was tarred with the same brush as the US market this week, only not quite as badly. Overall, the Canadian 30 year bond added 12 basis points to yield 5.50% at the week's end. In the US a very poor $US 15 billion 2 year auction added to the supply overhang from the quarterly refunding two weeks ago. The concern over the Fed's next interest rate move added to the uncertainty of the market. At the end of the week the US 30 year Treasury bond had added 19 basis points, to yield 5.58%. The Canada/US long bond spread remains firmly entrenched in negative territory at -8 basis points. (A basis point is 1/100th of a percent.)

It is interesting to note that interest rates on the US long bond have risen back to levels last witnessed before the economic melt down of late last summer and fall. Does this mean that the bond markets are returning to economic fundamentals. Has the only difference in markets tone been the unwinding of the 'flight-to-quality' trade which dominated the bond markets since mid-1998?

The North American equity markets were knocked back this week as investors had little reason to get involved until the testimony given by Federal Reserve Board Chairman Alan Greenspan has been digested. Mr. Greenspan's concerns over current equity valuations, and the potential for some nasty collateral damage should there be a downward correction has the equity market nervous.

Merger and acquisition announcements early in the week helped to boost the equity markets, however the comments by the Fed Chairman quickly took away any gains. United Technologies announced the purchase of Sundstrand for $US 4.3 billion; Beyond.com bought BuyDirect for $US 133.7 million; Dominion Resources bought Consolidated Natural Gas for $US 6.3 billion; Sempra Energy bought KN Energy for $US 1.8 billion; Olivetti announced its bid for the State owned Telecom Italia of $US 58 billion.

The TSE could not even tread water this week is it sank under the weight of resource stocks and the financial sector. Toronto shed 96.85 points, or 1.51%, to close the week at 6312.69. The TSE remains down 2.67% on the year, and 19.30% from its high in April of 1998. The DJIA lost 33.37 points in a wild week, to close down 0.36% at 9306.58. The Dow remains in positive territory on the year, up 1.36%, and is off 3.49% from its best levels in January. The S&P500 was down marginally, while the Nasdaq managed to hang on to a small gain for the week.

Next week brings the all important non-farm payrolls number in the US. This number is closely watched as an indication of the Federal Reserve Board's possible next move on interest rates. Look for the average hourly earnings figures to have a greater impact than the headline number. The bond markets are looking oversold on a technical basis, however a bearish tone has developed among investors. The bond market is looking at defining a new range for the long bond between 5.25% and 5.75%. Good trading.

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