FIRST QUARTILE ECONOMICS |
KEY ECONOMIC DATA: Most notable is the third consecutive month of stability in the level of manufacturing jobs after several months of robust gains. Industrial production flattened out in January and February and these data imply more of the same in March. Hourly earnings rose 0.3 percent in March and are up 4.0 percent yr/yr but remain below recent peaks. The payroll employment report has been at the root of more market turns than any other data series and even though it is somewhat suspect because of the weather impact, there has likely been a cooling in the labor market. To the extent the employment data tend to mirror other data for the month such as consumer spending and production, it follows April will likely be a friendly data month for bonds across the board. The recent surge in energy prices was at the end of March and the upcoming Producer Price and Consumer Price Indices should still decline on the month.
INTERNATIONAL EQUITIES: The S+P 500 hit new highs during the past week and posted a net gain of 2.5 percent. Most of the focus was on the Dow which rose 2.1 percent and broke the 9,000 barrier on Friday. In fact, the Dow gyrated around the 9,000 level a number of times on Friday but failed to close above and actually posted a net decline of 3 points on the day.
The main push for equities was on Thursday as Fed Chairman Greenspan said equities are appropriately priced, a far cry from his irrational exuberant references in late 1996. A contrarian might say this represents a capitulation that may mark a major top in equity prices. Certainly, even though interest rates fell on the week the fundamentals seem to be bad for equities. Specifically, soft employment numbers may confirm an economic slowdown that may generate prolonged damage to earnings prospects. Finally, with the re-emergence of Asian equity market weakness, it is difficult to believe North American equity prices can maintain recent momentum.
The big loser on the international front was the Japanese equity market with a significant decline of 7.3 percent. The Nikkei 225 has now given up two thirds of its spectacular 19.8 percent January recovery from December lows and unfortunately, from a technical perspective, the objective is now a re-test of the December low which represented a long term triple bottom. Nobody should be surprised if a new low is set since the Japanese economy is in the early stages of a recession that Japanese and international financial market participants have not faced up to yet. Similarly, other Asian markets have posted relapses after oversold/bottom fishing bounces early this year. Most relevant is South Korea which saw its equity market rise 75 percent from mid December to late January only to have 2/3's of these gains evaporate in the heat of economic reality.
One can argue that funds diverted from Asian markets will sustain North American and European markets and possibly propel them higher still. But one should also consider the improbability of a sustainably vigorous non-Asian economy amidst such economic malaise in a significant part of the world economy.
COMMODITIES: Oil prices consolidated on the week and posted a net decline of $0.80. Gold rose by $5.40 largely in response to the looming Japanese credit downgrade. Whether this response makes sense is debatable since the Asian scenario is now more deflationary than ever. In any case gold has been developing an upward bias of late and there do seem to be more buyers than sellers. I don't trust it and I don't buy it.
U.S. DOLLAR: The big currency story of the week was the surge in the U.S. dollar as the fiscal new year in Japan got off to a dismal start. (Lots of talk of economic collapse...a large bankruptcy or two...topped off by Moody's outlook revision from stable to negative for Japanese sovereign debt.) Some token Bank of Japan currency intervention was seen on Friday but not the usual efforts seen when the BoJ is viewed as serious. From here, it is reasonable to look for meaningful new highs in the Dollar/Yen as Japan's fiscal and economic problems will simply get worse before they get any better.
Today's 135.00 Yen level should have pretty clear sailing to about 137 before some trendline resistance sets in. Given the backdrop to the renewed Yen demise, one should think in terms of a general destination of 150 Yen over the next several months. In this framework the U.S. dollar has broken out against the DM as well, after several weeks of tight trading ranges on the edge of trendline resistance. Obviously, the DM does not have the same negative fundamentals as the Yen but will broadly lose ground amidst general U.S. dollar strength. From the current level of 1.8500, it should only be a few weeks before last summer's high of 1.90 DM is tested and eventually broken. I still think a logical target for this move is 2.0 DM, well before the end of 1998.
U.S. BONDS: As anticipated last week, bonds have begun a multi-point move which should soon take out the yield lows in January on 30-year Treasuries and hit at least the 5.50 percent level before any real consolidation takes hold. In a significant development, the entire Treasury curve through ten years now (again) lies below the 5.50 percent Fed funds rate which embodies a totally benign Fed through the balance of 1998. It may not be long before the Fed easing constituency comes back out of the woodwork. With prospects of a several percent rise in the trade weighted U.S. dollar in the months ahead and the renewed risk of economic fallout from Japan, this is not a far fetched notion.
Certainly, the latest employment report suggests an inflexion point may already be at hand in the U.S. economy. Personally, I think the Fed will welcome any kind of cooler economic growth and will be in no hurry to re-stimulate the economy. In turn this bodes especially well for long yields as inflation will remain dormant even longer. (The next few months should see a test of 1.0 percent on the year over year CPI trend, even though the core CPI should stay above 2 percent, while the apparent strength of Q1 GDP will make it that much easier to see an abrupt deceleration in Q2.)
CANADIAN DOLLAR: The C$ spent a trendless week in a range of 1.4144 to 1.4240 and closed a bit weaker at 1.4197 versus 1.4162 a week earlier. Broadly speaking, the currency remains in a mild corrective mode after the decent rally from late January. I still tend to think a general drift to the 1.38-1.39 area lies ahead but it is hard to get any more bullish than that.
A look at the domestic money market yield curve suggests the market is not looking for higher interest rates here over the balance of the year (maybe an easing at some stage is implied) while the trade balance data remain a negative for the currency. Against this background, expect near term currency weakness to be contained around 1.43 with resistance at the 1.4120 level and then 1.4050.
CANADIAN BONDS: Domestic bonds failed to keep up with the U.S. rally but were not far behind. Similar to the U.S. the domestic curve is relatively flat while the 2 year rate is even to 1 year Treasury Bills. This type of curve is consistent with a market that is in no particular fear of higher administered interest rates any time soon and in fact implies the next Bank of Canada move is a reduction in rates. (This makes sense if you believe the U.S. dollar will rise sharply in the months ahead and in turn so will the Trade Weighted Canadian dollar. The accompanying tightening of the Monetary Conditions Index may indeed allow for a rebalance via a somewhat lower Bank Rate.) Or perhaps this is the logical configuratation in a period of absolute declines in the stock of Treasury Bills and short term bonds as the fiscal surplus expands. In any case value now seems to be back in favor of the long end.
CANADIAN EQUITIES: The TSE 300 fell by 0.1 percent on the week with a split of a 0.4 percent decline in the TSE 100 and a 1.1 percent rise in the small cap TSE 200. Golds were the star performer on the week with a gain of 4.5 percent as gold prices rose 1.8 percent. Eleven of the fourteen TSE 300 groups declined. As discussed last week, the TSE 300 is facing overhead trendline resistance. The broad sectoral decline was all the more interesting given the nice rally in interest rates on the week.
April 6, 1998
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