Weekly Wrap-Up April 27 - May 1, 1998

Closing Numbers

The North American bond market faced a report in the Wall Street Journal this week indicating that the Federal Reserve Board in the US had shifted to a tightening bias from a neutral one. This sent the fixed income markets on both sides of the border south, as traders and investors sold securities on concern that the Fed would raise interest rates and the Bank of Canada would be pushed into doing so as well. Poor sentiment carried over from last week's close added to the down-draft.

The market has taken a bit of a wake up call from the shift in Fed sentiment towards a tightening bias, by focusing on economic fundamentals once again. Economically, there were some significant numbers released this week. In the US, existing home sales for March rose 2.5%, on a year-over-year basis, to a record 4.89 million units; durable goods rose 0.4%, ex-transportation rose 0.9%; new home sales were off 5%; the employment cost index was up a less than expected 0.7%, a drop of 0.3%; advanced first quarter GDP was +4.2%, with the price index +0.9%, down 0.5%. In Canada, the calendar was not quite as full with industrial prices for March down 1%, raw materials index down 2.7%; number of employees in February dropped 0.1%; weekly earnings rose 2.2%; hours worked dropped 0.2 to 31.0; GDP at factor cost for February rose 0.9%. Net, the numbers indicate healthy growth with little sign of inflation.

The economic data released early in the week added to the markets concern that the next Fed meeting (May 19) would see the FOMC exercise the tightening bias in the form of a rate increase. However, as the week progressed the economic data released indicated that the concerns over inflation raising its head at present are not well founded. Any real inflation is still a considerable way off in the distance. If the Asian concerns continue to be a drag on the export sector, there could be a natural cooling of the economy. It should be noted that much of the economic activity in the first quarter GDP numbers released in the US was related to a build up of inventories, indicating that overall demand may be ebbing.

The bond markets were rocked early in the week by the Fed news, but came back to close stronger by the week's end. The Government of Canada 30 year long bond traded as high as 5.77%, before buyers re-emerged to bring the yield back down to 5.64% by Friday's close. The Canadian 30 year long bond managed to shed a basis point over a volatile session. The US 30 year Treasury bond traded as high as 6.09% before economic data began to ease fears of an imminent Fed hike and investors brought the yield down to 5.93% at the close this week. The US 30 year Treasury shed 5 basis points this week. The Canada/US long spread narrowed into -35 basis points during the volatile session, pushing wider to close the week at -29 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets were not spared any of the ugliness associated with the shift in Fed bias to tightening early in the week. The financial sector, pipelines, and utilities were all hurt as fears of increasing inflation hurt the interest rate sensitive sectors. The equity markets also shifted their attention away from traditional measures of value such as corporate earnings reports and focused on the activity in the bond markets. With the Fed raising the spectre of potentially higher interest rates the equity markets are eying the bond markets closely.

An increase in interest rates causes the cost of borrowing for corporations to rise, eroding profit potential as more corporate income must be used to service debt. Higher borrowing costs also mean that corporations may not undertake potentially profitable projects due to the increased cost of capital.

After a volatile session the North American equity markets finished close to unchanged on the week, with the US exchanges showing a marginal increase. The DJIA closed the week at 9147.07, adding 82.45 points or 0.91% on the week. The Toronto Stock Exchange did not fair as well, closing in the red by 1.13 points at 7702.11, virtually unchanged. The TSE was dragged down by bullion which was hurt by rumours of selling by the Bank of Belgium in order to reduce debt, despite the inflationary concern early in the week. The Nasdaq and S&P500 recovered their large early week losses to close in the black.

Next week will bring a little more in the way of data for the market to swing its inflationary concerns around. In particular, Friday's release of US of non-farm payrolls. Any number that exceeds the streets expectations will send the markets south in a hurry. Nerves are on edge. Good trading.

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