Weekly Wrap-Up February 1-5, 1999

Markets in North American felt the impact of strong economic data, international concerns over fixed income supply and worries over the possible increase in short-term interest rates by the US Federal Reserve Board. Bonds and equities were weaker, with Canada outperforming on strength of the Canadian dollar.

The North American bond market saw prices plunge as international events and concerns over the Federal Reserve Boards next move on interest rates shock investors confidence. An improving $CAD helped the Canadian bond market to out perform the American market. Strong economic data and coming Treasury supply in the US was not supportive for bonds.

The Federal Reserve Board met for two days this week to discuss the continuing strength of the US economy. The deliberations of the FOMC left short-term interest rates unchanged. The market is concerned that the liquidity injected by the Fed during October of 1998, to stave off a liquidity crisis, has added too much strength to the US economy. The money supply continues to expand, economic data continues to show robust growth, and consumer spending continues to grow. Fears are mounting that the Fed's next move will be to raise rates, in an effort to aid in slowing down the US economy.

In Brazil this week the President of the Central Bank, Francisco Lopes, was fired after only three weeks at the helm. His successor, Arminio Fraga, was the former economic advisor to international financier, George Soros. Does advising a hedge fund lend itself well to managing the monetary policies of a troubled economy? The IMF seems to think so as a more gradual approach to the austerity the IMF wants to see from Brazil has been accepted.

Japanese Finance official, Mr. Miazawa, added to the meltdown of the Japanese bond market this week, stating that he was "not concerned" about the sell-off. Japan also announced that the current trade dispute with the US is not restricted to just the steel market. Concerns are growing about a trade war. Japan does not need this type of economic drag, as indicated by new car sales which fell in Japan for the 22nd month in a row, dropping 6.2% on a year-over-year basis.

Other concerns out of Japan this week include statements by political officials that the Bank of Japan should underwrite the Governments proposed bond issuance to bail-out the economy. Two problems occur with this approach, the first being that the amount of bonds which the government wishes to issue may have a "crowding out" effect on private borrowing requirements as a market already heavy with supply is swamped by more, and second the historical precedent that exists for the Bank of Japan underwriting Government debt during World War II which contributed to runaway inflation. The rating agency Moody's has stated that the later move by the Bank of Japan would be detrimental to Japan's foreign credit rating.

Russia has not escaped the week unscathed. The largest commercial bank in Russia, Uneximbank, missed a $US 12.3 million interest payment on $US 250 million in debt. The bank has two weeks to make the payment or be officially in default. This is a further indication of the continuing poor health of the Russian economy in general and financial system in particular.

The economic data released in Canada and the US continues to show an economy that is out preforming the expectations of the experts. In the US NAPM was 49.5, up from 43.5 last month; personal income grew 0.5%; personal spending rose 0.8% continuing the negative savings witnessed in the US for the last quarter and contributing to the lowest year-over-year savings rate since 1933 of 0.5%; same store retail sales rose 6.2%; factory orders rose 2.3% in December, for a year-over-year increase of 2.1% - the smallest since the recession of 1991; non-farm payrolls rose a stronger than expected 245,000, with the unemployment rate remaining unchanged at 4.3%. In Canada retail sales rose 1.2% in December for a year-over-year rise of 6.4%; employment rose 87,400 in Decemebr, although almost 2/3 of the increase was related to public sector hiring; the unemployment rate dropped 0.2% to 7.8%, the lowest level in eight and a half years.

The bond markets sold off this week, with the Canadian market outperfroming the US on the strength of the $CDA. The Canadian dollar rallied substantially this week as technical resistance levels were broken and short covering took place. As a result the Government of Canada 30 year long bond only sold off 13 basis points to close at a rate of 5.35%. In the US, economic strength and the meltdown of the Japanese bond market added 24 basis points to the US Treasury long bond. The Canada/US 30 year spread narrowed 11 basis points on the week to close at 1 basis point. With the US Treasury issuing 30 year bonds next week, look for this spread to narrow further before the trend reverses after the supply. (A basis point is 1/100th of a percent.)

The North American equity markets felt the heavy weight of reality hit this week. The valuations which investors had placed on the markets did not reflect the economic reality going forward. With the Fed on hold, investors must carefully analyze the cashflows associated with securities held in their portfolios. Many are over valued - Internet and technology stocks come to mind.

The merger and acquisition activity continued this week as several deals were announced and a couple rumoured. AT&T and Time Warner announced a stock swap agreement which would allow AT&T to deliver local phone service over cable lines; AOL bought MovieFone for $US 388 million; Societe Generale bought Paribas in France for $US 17.26 billion; Goodyear and Sumitomo Rubber of Japan are in discussions; and Deutsche Bank is rumoured to be in merger discussions with Newcourt Credit in Canada.

The TSE had a tough week but out performed most of the other exchanges on the continent. The TSE lost 1.43%, or 96.19 points, to close at 6633.37. In New York, the DJIA posted a mild loss of 54.59 points, or a drop of 0.58%, to close at 9304.24. The S&P500 struggled on the week losing 3.14%. While the Nasdaq, after posting a record high close on Monday of 2510.09, ended the week down 5.28%.

Next week brings a host of supply in the bond markets. The US Treasury starts it's quarterly refunding with 30 year bonds included in this week's offerings. While in Canada the Bank of Canada will issue 10 year bonds on behave of the Government. Look for more strong data, and a steepening yield curve as more concerns over the strength of the North American economy pushes long bond yields higher. The equity markets must wrestle with the valuations put on future corporate earnings after the substantial run-up in asset values that occurred in January. Good trading.

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