Weekly Wrap-Up May 12-16, 1997

Closing Numbers

All the anticipated volatility in the North American bond markets this week was for not. The onslaught of potentially market moving economic numbers out of the US did little to push market sentiment one way or another vis-a-vis Federal Reserve Board action at next Tuesday's FOMC meeting. The various District Fed reports released this week indicated moderate economic growth with minimal inflationary risk. US retail sales were down 0.3% for April, and the previous two months were revised lower. US PPI was down for the fourth straight month, lower by 0.6%, and CPI was up a modest 0.1%, but the core (ex volatile food and energy costs) was higher by 0.3%, mainly in the clothing component of the index, while industrial production remained unchanged. US housing starts should signs of continued strength as reported construction was +2.6%, with market analysts expecting a +1% increase. Strength still underlies the US economy. Although the immediate threat of inflation is not strong, the Federal Reserve Board Chairman, Alan Greenspan, has indicated that the Fed wishes to be pre-emptive. Given to continued strength of the US economy, and the hints of the spectre of inflation off in the future, economists are mixed on the outcome of next Tuesday's FOMC meeting. Comments by Richmond District Fed President, Alfred Broaddus, indicated that the US economy cannot continue to grow at its current pace, without inflation becoming a problem in the longer term.

The Bank of Canada Governor, Gordon Thiessen, released the Bank's opinion on monetary policy in Canada for the next six months. The monetary policy in Canada has been aggressively accommodative over the past 18 months in an effort to breath some life into a the lack-lustre performance of the Canadian economy. Signs of improvement are beginning to show, however the productivity gap is still large, unemployment is 9.6%, and inflation is still in the bottom half of the Bank's target range of 1-3%. There is still room for non-inflationary improvement, but as it turns out not with the help of monetary policy. Mr. Thiessen announced that Bank policy has shifted from accommodative to neutral, with the possibility of short-term interest rate increases in the near-term. An improvement in the $CDA may provide the monetary condition snugging the Bank of Canada requires, as a stronger $CDA on the world market will slow the growth of export driven industries, easing domestic pressures for a rate increase. The Canadian bond and currency markets loved the statement, as both markets improved significantly versus the US market on the week.

The trading in the bond markets on both sides of the boarder was choppy as Fed watching is all the rage. What will Mr. Greenspan do at Tuesday's FOMC meeting? Will the Bank of Canada match a move by the Fed? With the US and Canadian markets trading at the high end (price) of the recent trading range, there was little incentive to take the market higher on non-inflationary numbers. Most traders have been riding positive carry trades over coupon payment dates in order to have some cushion in case the Fed moves on Tuesday. The US 30 year Treasury bond finished the week 2 basis points weaker at 6.91%, trading in a narrow 5 basis point range on the week. The Canadian 30 year market did better, fueled by Mr. Thiessen's comments, posting a 4 basis point improvement on the week to close at 7.07%. The Canada/US 30 year spread has narrowed 6 basis points on the week to close at the tightest it has been in years at 16 basis points.(A basis point is 1/100th of a percent.)

The equity markets showed a greater deal of volatility over the week than did the bond markets. Although sentiment in the bond markets regarding a possible Fed move still influences the overall direction of the equity market. The DJIA and the S&P 500 set two new record closes on the week, but with significant retracements on Friday managed to just hang on to positive territory. The DJIA has set 6 record closes in the last 11 trading sessions, while the S&P 500 has set three records in the last 10 trading sessions. Both the Nasdaq and the TSE have been within sight of new records, but do not appear to be in reach of them. The TSE still looks like the ugly duckling, pulling up the rear, underperforming its southern neighbours and experiencing less volatility. The DJIA closed the week up 0.35%, or 25.14 points, at 7194.67 and the TSE managed to hang onto a 0.29%, 17.86 point increase, to close at 6247.38.

Now that the Bre-X saga is behind the market, and several margin traders have adjusted their life styles from steak tartar to Kraft dinner, you would think that the gold sector of the TSE would start to regain some of its lustre. Well, it ain't happened yet. Rumours that the German central bank, the Bundesbank, is revaluing its gold reserves, and may need to sell some of those reserves, to be ready for the EMU, took the shine off bullion as it also failed to break the $US 350 mark this week. Until a significant break of this level occurs, or inflation comes screaming back to the North American economies, gold is not going to shine. This will drag on the performance of the TSE, which is weighted about 9% in gold stocks.

The only event that any trader, investor or analyst is looking for next week is the Tuesday May, 20, FOMC meeting to determine US short-term interest rate policy until the next FOMC policy meeting July, 2. With all the rhetoric from the Fed over the last couple of weeks it is difficult to say what the Fed will do. Opinion is split on whether rates will remain unchanged or be increased another 25 basis point to 5.75%. Another rate increase would be prudent in terms of the Fed's stated forward thinking pre-emptive monetary policy strategy. The Fed could then lay-off any moves until after the summer is over to determine if the desired effects are beginning to manifest themselves. The initial 25 basis point hike on March, 25, will do little to slow an economy as large as that of the US. The Canadian market is closed on Monday for the Victoria Day weekend, and the US market will grind to a halt early Friday, as US traders look forward to the Memorial Day weekend next week. Good trading.

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