FIRST QUARTILE ECONOMICS |
Moving forward, the Bank of Canada’s tolerance for a softer currency has now been identified and currency traders will be more cautious in jumping on any bearish CAD bandwagon over the near term. The basic problems for the currency still remain, namely, the trade fundamentals (e.g. current account deficit and negative money market interest rate spreads to the U.S.). The fact that the Bank of Canada remains well stocked with foreign exchange reserves to support the currency in the open market is probably a key reason CAD will now tend to stabilize.
As for any general CAD rebound, this seems improbable as it once again appears the Bank of Canada has orchestrated a new trading range below 70 cents (1.4286) and would like to see this currency level do its work. Specifically, exporters need a boost to have any hope of returning Canada to a benign Current Account deficit over the next several quarters. As well, the looming invasion of cheaper Asian goods has to be countered to some degree. Accordingly, on a technical basis CAD remains in a bear market but at current levels the scope for meaningful new lows is negligible. Charts show CAD near the top of the trend channel which stood around 1.47 this week.
U.S. DOLLAR: The big dollar recovered from early week lows of 124.25 against the Yen and 1.7515 versus the DM. Closing at 127.00 Yen and 1.8300 DM the dollar rose by 1.0% and 3.0% respectively on the week. More importantly, support levels held and the dollar is poised for further gains. At this stage, most of the strengthening potential appears against the DM. A rekindled run at 1.90 remains a realistic scenario. The Yen has more positives in its favour right now and may have a lot of difficulty breaking above 130.0.
U.S. BONDS: It was a great week for bonds as last week’s closing debacle was largely unwound. Yields on 30 year Treasuries fell 16 basis points with similar declines in the 5 year area. The positive tone emerged on a steadier U.S. dollar and then Fed Chairman Greenspan’s testimony to the Senate Budget Committee on Thursday. The Chairman reiterated his expectations of economic drag from Asia and fixed income markets were back to thinking about eventual Fed ease sometime later in 1998. From a technical perspective, 30 year Treasury yields came close to the 6.0% level before declining sharply on Thursday and Friday. There is now good reason for another run to recent lows which were driven more by flight to quality than true bullish market psychology.
CANADIAN BONDS: The domestic market was lucky to see the rally in the U.S. as the Bank Rate increase and currency weakness led to a significant underperformance of the U.S. market. Although 30 year Canada yields were essentially unchanged on the week, spreads to the U.S. tightened by some 15 basis points. The spread compression was 36 basis points in the 3 month area.
On a more spectacular basis, the domestic yield curve flattened by 45 basis points from 2 to 30 years. The 2-30 year spread now stands at 57 bps versus 104 bps last week and 175 bps just three months ago. Obviously, the curve is taking tighter monetary policy in stride and this serves as a good reminder of the underlying value of longer term Canadas.
CANADIAN EQUITIES: The TSE 300 rose a respectable 3.2 % on the week and more than kept pace with the broader U.S. market for the first time in a while. Conglomerates led the upside with a 7.8% rise followed closely by a 7.4% rise for the oil and gas sector and a 7.1% gain in metals and minerals.
INTERNATIONAL EQUITIES: The U.S. indices produced a decent showing on the week as the S+P 500 rose 2.4% and set a new intra-day and closing high on Thursday in the wake of the Greenspan speech. Nevertheless, while the S+P 500 is up 25% yr/yr, the gain over the past six months is just 3.5%, most of which occurred this week. Technically, the S+P 500 has established a ceiling in the 985 area with several daily closes in this area since October. Other U.S. market indices remain considerably below October peaks. Given Allan Greenspan’s expectations of a slower U.S. economy ahead, a meaningful and sustainable gain in equity prices appears remote.
CANADIAN ECONOMIC DATA: November saw a GDP decline of 0.3% which was partly related to the postal strike but had more to do with the declines in wholesale and retail sales reported last week. So far, Q4 real GDP is shaping up for a gain of about 1 to 2% annualized versus the recent 4% trend. That’s right, even if December GDP grows by a full 1.0%, Q4 GDP will post a gain of about 1.8% annualized. The cumulative 175 basis point rise in the Bank Rate since June, has not likely had any impact on the economy as of yet, so the fact the economy has been losing steam of late on its own suggests potential for a sudden and more pronounced spell of economic moderation as 1998 unfolds.
The U.S. received a mixed data slate from a fixed income market perspective this past week. The Q4 Employment Cost Index rose by 1.0% with an unwelcome boost from benefit costs. The Conference Board’s Index of Consumer Confidence plunged 8.9 points to 127.3 in January. Durable goods orders fell by 6.1% in December while the Chicago Purchasing Managers’ Index for January eased to 57.7 from 58.1. Q4 GDP rose by 4.3% but a significant inventory buildup suggests slower GDP immediately ahead.
FUTURE DATA: The key Canadian data report next week is Friday’s employment report for January. The U.S. market is looking ahead to the National Purchasing Managers’ Index on Monday and the ever important Non-farm payroll report for January on Friday. (There is some chance that ice storms in the Northeast affected total employment growth during the month.) In between, there is an FOMC meeting that is virtually unanimously expected to result in no change in the Fed Funds rate. It is now a year since the Fed last made a move on interest rates (25 bps tightening) and the previous move was a year earlier (25 bps easing). But while the Fed Funds rate is net unchanged from two years ago the “real” Fed Funds rate has increased from about 2.6% to about 3.8% as the yr/yr CPI has plunged to 1.7% from 2.9%. Hence, there is more policy restraint in place than is often realized.
Monday, February 2, 1998.
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