Weekly Wrap-Up February 23-27, 1998

Closing Numbers

The North American fixed income markets had several significant events to deal with this week. First, south of the border, the two day Humphrey-Hawkins testimony by Federal Reserve Board Chairman Alan Greenspan laid the grounds for market confusion. Second, Canadian Finance Minister Paul Martin delivered the first balanced budget at the federal level since the 1960's. Neither market responded with much vigour to either event, leaving bonds feeling heavy and trading on technicals.

The Canadian Federal Government's budget had been substantially pre-released over the past several weeks, leaving little in the way of surprises for the financial markets once the budget had finally been delivered. The ratings agencies took little comfort from the budget due to the increase in program spending and the reluctance of the government to reduce net public debt until the year 2000. The onerous tax burden which the Canadian tax payer shoulders was not reduced substantially, although individuals making less than $CDN 50,000 per year are no longer subject to the 3% federal surtax on income.

The largest initiative entered into by the Canadian government is an investment in the future, with the implementation of the Millennium Fund, which is a $2.5billion fund aimed at helping students in post-secondary education. Additional tax incentives were granted to parents investing for the purpose of their childrens future educational needs.

Overall, the budget came as expected and many observers believe that the Federal government will achieve their stated targets in the budget due to the conservative nature of the assumptions utilized. Some of the Canadian balanced budget euphoria may also have been dampened due to the recent US announcement that they too would be in a balanced budget position next year. No surprises, with achievable targets.

The Humphrey-Hawkins testimony given Tuesday and Wednesday by Fed Chairman Greenspan left the markets confused as to the possible direction the Fed may move over the next year, vis-a-vis interest rates. The Fed Chairman indicated that the US labour markets are tight and wage inflation remains something that the Fed must be vigilant in subduing. The need for a pre-emptive move may be necessary if labour productivity gains do not keep pace with wage increases. However, Mr. Greenspan also indicated that "storm clouds are massing over the Western Pacific" and headed this way, in a reference to the potential economic impact on the North American economy of the Asian contagion. Increasing concerns are developing with respect to the possible deflationary effects on the North American economy of a host of cheap Asian imports, a slowdown in demand in Asia for North American produced finished goods, and a continued slump in world commodity prices. The net result is a neutral bias from the Fed with the possibility of an ease in the Fed funds rate unlikely in the near-term. Bond markets sell off.

There were a host of economic numbers released this week which pointed to continued growth with little signs of an inflationary resurgence. In the US, CPI for January was unchanged, with the core rate up 0.2%; consumer confidence rose to 138.3 in February; real earnings grew 0.9% in January; durable goods orders rose 0.7% for January, with a 0.3% gain with the transportation component removed; and fourth quarter GDP grew 3.9% with the price index rising 1.4%. In Canada, the budget was the big news, however industrial production prices in January were unchanged, with raw material prices down 3.1%; CPI for January was 1.1% year-over-year, +1.2% ex food and energy. The Canadian CPI data was impacted by an increase Quebec provincial sales tax, which will permanently add 0.1% to the index, as well as an increase in tobacco tax, and food prices as a result of the ice storm. The ice storm effects on CPI should be unwound over the next month or two. With inflation just crawling back into the Bank of Canada's target range of 1-3% for long term price stability there is little likelihood of a near-term interest rate move by the Bank.

The Canadian 30 year long bond added 2 basis points of yield over the course of a lack-lustre week to close at 5.78%. The US long treasury bond closed the week 6 basis points weaker at 5.94%, after testing the top end of the recent trading range of 6%. The Canada/US long spread moved deeper into negative territory, at -16 basis points, as Canada outperformed the US in an underperforming market. Fundamentals are still strong, however supply and technicals have decuple the bond markets from the equity markets. (A basis point is 1/100th of a percent)

The North American equity markets posted solid gains on the week as the New York based markets posted record highs. The DJIA set three new record highs on the week, closing above 8500 for the first time. The Nasdaq and the S&P500 also posted several record closes this week. The Toronto exchange is still suffering from depressed world commodity prices, lagging its southern neighbours significantly.

This week the TSE managed to outperform, even the rampaging US markets, posting a 2.48% gain, or a 171.75 point gain to close at 7092.49. This is still 117.44 points shy of the record high close of 7209.93 established October 7, 1997. The DJIA added 131.78 points to close at a record 8545.72, a gain of 1.57%. The S&P500 added 1.46%, while the tech heavy Nasdaq received a boost from Dell computer to close 2.45% stronger.

The equity markets feel strong at present as RRSP and IRA money pour into the market ahead of tax filing time. However, the next set of quarterly earnings are not expected to be as strong as the last, as Asian influences begin to show up in corporate performance. The bond markets widely anticipate a continuation of supply coming to the market at current levels as governments and corporates take advantage of low long term rates to fix their financing costs. The market fundamentals remain strong for a continued healthy economy with little signs of resurgent inflation. Good trading.

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