Weekly Wrap-Up November 17-21, 1997

Closing Numbers

The North American bond markets had a host of economic data to digest this week. However, little of the information provided by the numbers on the state of the two economies had much impact on the direction interest rates took on the week. Fundamentals, while regaining a measure of importance to the markets, are still in the back seat as conditions in the global equity markets continue to dominate investor sentiment. Numbers released in Canada this week indicated an economy which is showing modest domestic growth, with little concern over the near-term emergence of inflation.

Canadian manufacturing shipments decreased 0.3%, inventories grew 0.8%, unfilled orders increased 1.7%, new orders rose 0.2%, and wage settlements grew 1.1%, down 0.6% from the previous month. Canada's trade balance decreased $CDA 321mil, to +$CDA 869mil, with imports growing 1.6%, and exports rising a mere 0.2%. On the inflation front, Canadian CPI fell 0.1% to 1.5% annualized, with the total measure rising 0.1% month-over-month, and the core rate increasing by the same amount. All the economic data taken together made it difficult for the public to believe that Bank of Canada Governor, Gordon Thiessen, must raise rates in the next six months to ward off inflation.

Mr. Thiessen made the comment at his semi-annual state of the economy address this week. The highly toted, and very public, Monetary Conditions Index, which measures the monetary stimulus the Canadian economy receives based on a host of inputs, including government fiscal policy, and the value of the currency, indicates that Canadian monetary conditions are highly stimulative at present and need to be adjusted in order to be less accommodative. Mr. Thiessen sated, "Persevering low inflation is a pre-requisite for making the (current) economic expansion a long-lasting one." Every indication was made, short of giving a date, that Canadian short-term interest rates will rise in the next six months. Having made this same statement repeatedly over the last three months, the Bank of Canada is getting itself into a crediblity problem with the international markets.

The currency remains under pressure specifically because of the success which the Federal Government has had at managing its fiscal accounts, and the desire that the Bank of Canada has indicated to raise interest rates in order to keep inflation at bay. With global deflation becoming a real concern, raising interest rates to stem potential future inflation may not be the appropriate policy at present. With the turmoil the $CDA has been in lately, raising rates to defend the dollar would just provide international currency markets with another reason to further test the Bank of Canada's resolve. No policy move should be made until some form of stability re-emerges to the currency, and equity, markets.

The US released inflation data as well this week. US domestic CPI rose 0.2%, with the core rate up 0.2%, annualized to a rate of 2.1%, the lowest rate in 10 years. As for the larger economy, industrial production rose 0.5%, growing for the 15th consecutive month, capacity utilization grew 0.1% to 84.3%, housing starts rose 1.4%, building permits grew 1.1%, and the US trade deficit grew 17%.

With all the information out, one might have suspected a choppier ride in bond land. However, both the Canadian and US markets rallied on the week, posting record low yields for the recent past as the flight to quality rally continued. The Canadian 30 year bond shed 5 basis points to close the week at an all-time record low yield of 5.91%. The US 30 year Treasury also posted a 5 basis point decline in yield, posting its lowest yield in over two years at 6.05%. The Canada/US 30 year spread remains firmly in negative territory at -14 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets were still feeling the effects of the Asian economic hangover. The Canadian economy's reliance on the natural resource sector translated into a poor showing in the equity markets on the week. Concerns that slow downs in the emerging Asian economies will translate into decreased demand for raw materials, as well as the continuing weakness demonstrated by the commodities markets, particularly metals and papers, placed the TSE as the goat of the North American exchanges this week. Even the anticipation of strong earnings reports for the banks could not help Toronto keep up with the big boards in the US. The US markets managed to reverse the recent trend of following the wallowing Asian exchanges lower, and posted solid independent gains for the week. The DJIA posted a 4.08% gain on the week, with the Nasdaq's 2.35% gain pulling up the back of the bus. Strength in the financial sectors, interest rate sensitive stocks such as utilities, and strong dividend stocks like pharmaceuticals helped New York do better.

On the week the TSE added 47.75 points, or 0.71%, to close at 6773.93. The DJIA soared 308.59 points, or 4.08% to close at 7881.07. The Canadian economy's reliance on natural resources is holding back the performance of the TSE.

Concerns over the continued health of the Asian economies should continue to dominate the global markets, with a large amount of attention being devoted to the issue at the APAC conference in Vancouver. The request by Yamaichi, the 4th largest broker in Japan, to cease operations is likely to draw even more attention to the poor health of the Japanese economy. There have been concerns that the Japanese government would sell North American fixed income securities in order to stimulate the domestic economy. The Finance Ministry has indicated that this is not, at present, an option.

Next week brings a holiday shortened trading week in the US, with Thursday the US Thanksgiving. Look for many players to take a long weekend and extend their time off. The economic data of interest is existing home sales, US GDP Q3, durable goods, personal income and the Chicago PMI. There has been some talk that the flight to quality rally which has driven yields to record lows in North America may be coming to an end, but with Yamaichi this may not be true. If this is true, look for the markets to start concentrating on fundamentals again. Good trading.

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