FIRST QUARTILE ECONOMICS |
Ottawa replenished its foreign exchange reserves with a U.S. $2.0 billion, 5-year global issue on Wednesday, but this has no immediate relevance for the level of the Canadian dollar. It does not mean Ottawa is getting ready for more currency turbulence either.
The upcoming week includes the report of the December trade surplus and this will be the currency’s focal point. The CAD decline of late has almost nothing to do with any crisis in foreign confidence and everything to do with the unprecedented collapse of the trade surplus. Fortunately, exports have continued to grow to record levels but have been vastly outpaced by import growth. It follows that a softer Canadian economy has to be the prelude to a break in import momentum which in turn will give some support to the currency. However, just as the currency lagged the trade surplus reversal by several months the corollary will hold true as the trade surplus bounces back. The CAD is stuck here for some time to come.
U.S. DOLLAR: Very subdued trading ranges were the case all week but the dollar managed gains of 0.5% and 1.0% versus the DM and Yen respectively. Despite the apparent calm, the dollar remains near important trendline support versus the Yen, at around 123.0 Yen, and must not break below. If a break does materialize, the three-year uptrend is probably over and a decline to the 110 -115 Yen range is a definite possibility (over several months that is).
In any case, the dollar’s three-year uptrend versus the Yen is part of a rising wedge that eventually has bearish consequences. Given the Bank of Japan has recently signaled a peak for the dollar in the 130 to 135 Yen range, it may be hard for the dollar to amass the underlying support to advance much above current levels. Accordingly, if or as the 130 Yen level is approached over the near term, this could represent a major long term opportunity to short the dollar. Since the odds favour a ballooning of the U.S. trade deficit with Asia in 1998, such a currency scenario is also justified on fundamental grounds.
U.S. BONDS: The quarterly refunding was absorbed this past week and interest rates were little changed. Long Treasury futures have traded in a 2 point range over the last two weeks and have had the identical high for three consecutive weeks. Considering the rally in equity markets during the past several weeks, bond prices have held in quite well. Euro-dollar futures continue to imply no Fed action in 1998 which remains an underlying positive for bonds. All that remains to be seen is the economic slowdown that Fed Chairman Greenspan expects and there is a solid chance the market will start pricing in some form of Fed easing stance in the second half of 1998. Whether it happens is not as important as the fact such expectations will open the door to new lows in long yields in the months ahead.
It may be a bit early, but market participants are now likely to settle back in anticipation of the Fed Chairman’s Humphrey-Hawkins testimony on February 24th and 25th. With equity markets back in “irrational exuberance” territory, one has to wonder if Mr. Greenspan is ready to take another swipe at dampening expectations of perpetual strong gains in equity markets. Imbalances are almost always at the root of cyclical downturns (usually inflation) and to the extent the only real imbalance with potentially threatening consequences for the economy is the overvalued level of equity prices, it is hard to believe equity prices will survive Mr. Greenspan’s testimony. Accordingly, what’s bad for stocks should be good for bonds in this case.
CANADIAN BONDS: The market is starting to focus on the upcoming Federal Budget on February 24th. A surplus or at worst a balanced budget is expected for 1997/98 just ending and everyone is looking for a surplus for 1998/99.
All this is priced into the market and indeed is old news. The real focus of the market will be dealing with the so-called fiscal dividend and whether a return of traditional Canadian government largesse is back on the agenda.
It is unlikely however, that any fiscal “victory celebration” will emerge on Budget Day and the signals about future spending will remain subdued. We have grown accustomed to Budgets as major domestic capital market events but they have lately become mere matters of record. Nothing special is likely to happen to the Canadian dollar and any traders working the evening shift will have a boring night.
CANADIAN EQUITIES: The TSE 300 rose by 1.8% on the week. The Financial Services sector lead the gains with an increase of 5.4% on the week while Transportation was not far behind with a gain of 5.1%. Paper and forest products fell 2.5% to lead the declining sectors. The TSE 100 accounted for all the net gains with a 2.3% increase while the TSE 200 was down 0.4% on the week.
INTERNATIONAL EQUITIES: The S+P 500 hit a new high this week as did the Dow. The Nasdaq and Russell 2000 remain slightly below record levels set last year. Japanese and Hong Kong markets were down on the week following strong recent gains.
FUTURE DATA: Canada has a fairly extensive slate of data releases ahead with Manufacturing Shipments and New Orders for December on Monday; Wholesale Trade for December on Wednesday; December Trade Surplus on Thursday; and December Retail Sales on Friday. The minutes of the December 4th, Bank of Canada Board meeting are released on Wednesday and are always worth a passing note in the media.
The U.S. market is closed for President’s Day on Monday while the weekly data calendar will likely fuel some volatility in financial markets. January Industrial Production on Tuesday is expected to rise about 0.3% versus 0.5% last month. January Housing Starts on Wednesday should ease a bit in response to inclement weather, while the Producer Price Index for January is expected to fall 0.2% with no change at the core level.
Monday, February 16, 1998.
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