FIRST QUARTILE ECONOMICS |
A string of firm economic data reports for December propelled the currency (manufacturing shipments, wholesale sales, trade surplus and retail sales) while there is a degree of comfort heading into Tuesday’s Federal Budget.
Some participants took solace in the Supreme Court deliberations on the legality of unilateral Quebec separation while the inflammation the whole process has stirred among the Quebec electorate has not been fully appreciated yet. A Leger & Leger poll reported in the Globe and Mail on Saturday indicated almost 70 percent of Quebec voters think they and not the Supreme Court should decide if Quebec has the right to secede from Canada. The poll also showed a referendum on independence would lose by a margin of 52.6 percent to 47.4 percent. As part of the equation, talk of a Spring election in Quebec has intensified.
From here, the Canadian dollar may have some room to improve but let’s not get too excited. Markets have interpreted the economic strength as suggesting Canada faces higher interest rates ahead (the IMF prescribed higher rates to keep a lid on inflation) while the bond market thinks in terms of the firm currency allowing rates to hold steady. The Budget is likely to have no follow through positive impact on the currency as a lot of positives are already priced in. From a technical perspective, it seems the CAD could reach the 1.41 level before major resistance sets in.
At this time, there is a reluctance to get too worried about any Quebec impact on the currency, especially since any future referendum will be well into 1999. However, we have already enjoyed our quiet time on this topic and maybe the market is in for more turbulence in general from this issue.
As for higher interest rates, the Monetary Conditions Index has firmed to new levels of tightness versus the past two years and it is doubtful the Bank of Canada has any inclination to raise the Bank Rate. The upcoming comments on the U.S. dollar indicate scope for more general gains and hence further tightening of the MCI over the very near term.
U.S. DOLLAR: The dollar gained strongly against the Yen but was neutral versus the DM during the past week. The big event was the newly unveiled but long anticipated Japanese economic package (designed to boost the economy) on Friday. Ultimately, the details were virtually all regulatory in nature and were not viewed as immediately stimulative or even supportive for the economy. To the extent that Japanese equity markets have anchored rallies across the globe since mid-January based on expectations of Japanese government measures to limit the domestic impact of the broader Asian economic debacle, there is indeed no strong sense the markets’ buoyancy has been justified.
Over the weekend the G7 met and issued the usual hollow communiqué. Nothing of relevance to currency levels was said.
Over the near term, the dollar’s strong bounce from recent corrective lows in the 123 Yen area have re-kindled optimism about a continued uptrend. Last week’s letter set out the chart depicting the three year dollar/yen uptrend and the importance of the 123 Yen area. For the time being, the dollar should strengthen in the wake of the Japanese economic package disappointment. As the Iraqi military scenario moves closer, the dollar should also tend to strengthen. Reasonable trading levels over the near term should include a break above 130 Yen while a push to 1.84 DM is also probable.
U.S. BONDS: Treasury futures broke above the identical highs set the prior three weeks but posted a net decline on the week. The data was good for bonds as January Industrial Production was flat and the Producer Price Index fell 0.7%. However, the string of new daily records for equities simply kept the bond market at bay.
Looking ahead, the January CPI report should result in a yr/yr gain of about 1.5 percent versus 1.7 percent in December while the core rate might hit 2.0 percent versus 2.2 percent the prior month. The bigger focus is the Fed Chairman’s extensive speaking agenda during the week as the Humphrey-Hawkins testimony is delivered to the House and Senate on Tuesday and Wednesday respectively, while other speeches are set for Thursday and Friday.
Notionally, there is a moderate degree of anticipation over what Mr. Greenspan might say. Bits and pieces of the Chairman’s thinking have worked through the financial markets over the past few months and most of it has been favorable for fixed income securities. However, with equity markets at new highs, in apparent total disregard for any risk from Asia, there is a better than 50 percent chance the Fed Chairman will take exception to the level and new found momentum of equity prices. The risk for financial markets next week appears to call for some equity market turbulence which in turn would be positive for bonds.
CANADIAN BONDS: The market’s primary focus is the Federal Budget on Tuesday, however the U.S. market will dominate as usual. Given the recent gains in the Canadian dollar and the prospects for a little more currency strength, there is a tendency for the yield curve to steepen as expectations of Bank of Canada tightening subside.
It will probably not happen as part of this budget process but there is some chance the Minister of Finance will announce the new inflation targets beyond 1998. The present 1 to 3 percent target for the core CPI is only in place through 1998 and something should be announced relatively soon. Since the original inflation targets were announced in the 1991 Budget there is at least some case to expect a similar venue for this very important policy guide.
Whether they are announced this week or in a few months, the inflation targets could be a much more crucial benchmark for domestic financial markets than generally perceived. Specifically, the current 1 to 3 percent target range was set with the view U.S. inflation would probably average or exceed the 3 percent level. As long as Canadian inflation was held to a central tendency of 2 percent, this would form the basis of long term competitive gains versus the U.S. A further benefit would be the gradual upward bias of the Canadian dollar which would allow for “Made in Canada” interest rates.
During the past two years the "Made in Canada" aspect of interest rates has been achieved, but in order for this to be sustained inflation must be held below that in the U.S. in the future. As this week’s data releases for the U.S. will indicate, the core level of U.S. inflation is now 2 percent and there is good reason to believe the Fed will take monetary steps in the future that will constrain inflation to the 2 percent range. If this is true, Canada somehow has to target an inflation rate below 2 percent.
Accordingly, the next set of domestic inflation targets will have to be in the 0.5 to 2.5 percent range with an implicit central tendency of 1.5 percent. With Canadian inflation currently below 1 percent, this is the perfect environment in which to implement the new guidelines.
CANADIAN EQUITIES: The TSE 300 fell by 0.7% on the week. Only four groups rose on the week as Utilities led the way with a 2.5% gain. On the downside, Golds lost 6.2% and Metals and Minerals lost 3.5%. Financial Services fell by 1.7%.
INTERNATIONAL EQUITIES: The S+P 500 hit several new daily highs during the past week for a gain of 1.4 percent. The Hong Kong market extended its recent gains with a 3.2% advance, but the Japanese market fell by 0.2% on the week. European markets were strong.
Monday, February 23, 1998.
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