Weekly Wrap-Up March 23-27, 1998

Closing Numbers

The North American bond markets were mixed this week for economic and fundemental reasons. There was a continuation of the heavy corporate issuance in the US in the face of 2 year and 5 year Treasury auctions, while the Canadian market still suffers from a lack of corporate supply. As well, the Provincial supply of bonds in Canada has begun to dry up as various Provincial Governments go into their budgetary black-out periods. Back of Canada Governor Gordon Thiessen reminded the markets of the central bank's continued vigilance against inflation. This type of talk would normally have hurt the Canadian bond markets, but with Jean Charest announcing his intention to leave Federal politics and join the Province of Quebec Liberal party in an effort to challenge separatist Parti Quebecois leader Lucien Bouchard, the Thiessen comments were overshadowed.

On the data front, there were several economic releases this past week. In the US, durable goods orders dropped 1.7% in February, but were actually 0.5% higher with the transportation component removed; existing home sales rose 8.7% year-over-year; personal income rose 0.6%; personal consumption rose 0.4%; final fourth quarter GDP came in as expected at +3.7%, with a price deflator of +1.4%.

In Canada there was a little bit more teeth to the numbers, as investors analyzed the data for signs of future inflation. The economic numbers this week showed the composite index rose 0.5% in February; industrial price index fell 0.1%; raw material index decreased 1.4%; department store sales rose 1.7%; average hourly earnings rose 1.4%; hours worked was unchanged; CPI rose 0.1%, up 0.5% ex food and energy for a year-over-year increase of 1% for the headline number and 1.6% for the core inflation rate.

There were a few issuers in the Canadian bond market taking advantage of the light supply calender and tapping the market. Talisman took advantage of the pop in oil prices to come to market with $CDA 150million 5 years at +58 basis points. Of particular note was the Bank of Nova Scotia deal of $CDA 600million 5 year +5 year fixed /floater deal which came at +30 basis points, and was the largest single tranche deal ever done in the Canadian market. This is an indication of how desperate investors are to add yield to their portfolios. Secondary supply in the Canadian corporate market continues to be thin, with dealers continuing to complain about having no product to offer clients. For those who hold corporate bonds as part of their Canadian portfolio there will be some cheering at month end as spreads in the corporate bond market have continued to narrow.

Due to the robust nature of the Canadian economy, and buoyed by the Charest move to Quebec provincial politics, the Canadian bond market managed to outperform the US over the course of the week. The Canadian 30 year long bond was unchanged at the end of the week yielding 5.71%. The bond has been trading in a narrow range, with pro-traders buying on dips and selling into any strength. The US bond market added 7 basis points to the 30 year Treasury bond, to close the week at 5.96%. Concerns of an oil driven inflationary shock gripped the US market as it underperformed the Canadian market by 7 basis points. The Canada/US long bond spread closed the week at -25 basis points, after posting a record low of -26 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets took different paths this week based on the same information. After the announcement by OPEC and non-OPEC nations that there would be an effort to reduce global oil production in an effort to stabilize prices, the Canadian equity markets rallied, while the US markets sold off.

In the US many analysts and investors are concerned that corporate earnings do not justify current price levels in the equity markets, and the potential for an increase in the cost of oil will only hamper efforts at increased earnings. The tight US labour market is also causing an erosion of corporate earnings as companies are paying higher wages without receiving proportionately higher prices for their goods. These factors point to disappointing corporate earnings going forward.

In Canada, the resource heavy stock markets loved the increase in both oil and gold prices this week. Investors were seen selling the financial sector to buy the resources as they attempted to do a little portfolio rebalancing ahead of quarter end. News of the OPEC attempts to raise the price of oil through a reduction in output provided the impetus for the oil and gas sectors move. While the belief that the European Bank, which will be responsible for the single European currency will hold up to 30% gold reserves helped gold catch a bid. The move by Russian President Boris Yeltsin to fire the entire government didn't hurt the prospects of gold, as a certain amount of political instability was introduced into the market.

One analyst remarked that the price of oil at $16, is like the difference between the price of gold at $279 and $299; the industry still goes bankrupt. This may be a little extreme, but also an indication of the economic reality for the resource sector. As for the scheduled OPEC meeting for March 30, 1998 the questions remain; 'Will the member states be able to maintain the production reduction or will there be some leakage?'; 'Will the production roll back be made off of the existing production levels or the stated quota levels established in November of 1997?'. The OPEC nations have never had a good track record with maintaining the quotas which they establish, so why should this time be any different?

The TSE was the darling of the North American exchanges this week adding 2.83%, or 209.69 points, to close at 7622.53. The Toronto exchange posted 4 record closes this week and closed the week above 7600 for the first time. All of the activity came from the kick start the TSE received from the resource sector. The Dow had a lack lustre week, starting out weak and tapering off. The DJIA closed down 1.24%, or 110.35 points, at 8796.08. No new record high closes for the Dow this week. The Nasdaq and the S&P500 posted record high closes over the week, but finished poorly.

Next week brings the economic number which many feel will be the catalyst for the Fed policy over the near-term, US non-farm payrolls. With the US labour force being so tight, and wage settlements beginning to outpace productivity gains - growing at a pace significantly above the core inflation rate of the US - there are growing possibilities that the next Federal Reserve Board move in the US will be to raise short-term interest rates regardless of the effects on the Asian economies of a stronger $US. If that happens watch the long end of the bond market rally into the next millennium. The employment figures will not be released until next Friday, so there will need to be a really good reason for traders to get too far from home ahead of the number. Good trading.

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