FIRST QUARTILE ECONOMICS |
The Japanese market gave up 2.6 percent on the week and I still think the December/January low will be revisited over the next several months. That would mean a decline of about 7 percent from current levels yet there is no compelling reason for those lows to hold. The Dec/Jan blowoff coincided with a triple bottom trend line dating back to 1991 and it will not be pleasant for the global equity arena if those levels give way. In the meantime, they bear close observation and are set out in the chart below.
U.S. DOLLAR: The dollar appears to have split its recent trend versus the Yen and DM. Despite all the talk of potential BoJ intervention, the Yen has eroded to the 133 area versus 131 last week and the recent low around 127. Confidence in the efficacy of the latest fiscal package has quickly disintegrated and another foreign exchange market skirmish with the BoJ is looming.
The dollar’s status against the European currencies is somewhat cloudy at present as the founding EMU members and currency ratios for the EURO are set for announcement over the past weekend. Despite more high level indications that higher German interest rates are not in the cards in 1998, currency market participants are temporarily buying the DM in case there are any near term surprises in its favor.
Another play is to sell the Yen versus “Europe” which has also contributed to the split in the dollar’s recent strength. As shown in the following chart, the DM has convincingly broken above a one and a half year resistance line versus the Yen, and now targets the upper channel line of the trading range going back to mid-1995. For the near term then, the dollar will likely lose some ground to the DM but the magnitude of the underperformance is limited. This renewed DM strength will make it harder for the BoJ to resist Yen weakness since it is now originating from both major currency groups.
U.S. BONDS: A look at weekly closing levels would suggest an uneventful week just passed but the daily action proved quite volatile. The week started off badly amidst a Wall Street Journal article that indicated the Fed changed its “next likely move bias” to a tightening, at the recent FOMC meeting. The street seemed to take this to mean an automatic tightening was likely following the May FOMC meeting and long bond prices fell 1 1/2 points on Monday.
On Thursday, following the report of another benign Employment Cost Index gain for Q1, long bond prices gained 1 1/2 points and closed up a touch on Friday. As things currently stand, the market continues to give strong weight to the ongoing excellent inflation environment. A reading of the FOMC minutes during the past two years indicates the Fed usually has a bias toward tightening in place yet there has been only one tightening since then (March 1997).
Nevertheless, more technical damage was done during the past week as the 6 percent level was significantly broken, if only for a few days. Fortunately, the late week rally has taken the yield to the 5.95 percent area but this is now close to resistance in the 5.90 percent range.
The following chart sets out the nearby long Treasury future price trend over the past year. Clearly, the channel uptrend is over but will be salvaged if prices can move back into the old channel. What will it take to make this happen? It just so happens, the April employment report is on tap next Friday and represents the perfect catalyst for the next move. Recall, last month’s report showed a decline of 36,000 jobs based on unusual weather but also some legitimate weakness. Another moderate employment showing should be enough to push bond prices meaningfully higher.
Some people have been worried about a top for the U.S. dollar that will drive interest rates higher. I think the outlook for the Yen is very bad now that the DM represents another flank of pressure. There may indeed be some U.S. bond turbulence upon BoJ dollar selling (apparently the recent Yen support action involved the selling of a record $21 billion U.S. dollars, most of which would be in the form of very short-term Treasury securities) but this has got to be viewed as temporary if it even happens.
The U.S. economy remains the strongest and among the least inflation prone economies in the world right now and that is as good a currency fundamental as you can get.
COMMODITY PRICES: A bad week for gold prices as the precious metal fell by $10 to $302 (a 3.1 percent decline). Continued excellent U.S. inflation was a negative for gold during the past week as was concern about gold’s reserve role in the new European Central Bank (ECB). With the EURO to be defined over the weekend, the price of gold fell by $4.30 on Friday, amidst holiday-thinned May Day trading.
Oil prices got a nice upward jolt on Friday as market participants have become suspicious of a joint Mexico/Venezuela/Saudi pact to further cut output and buoy prices. West Texas crude rose by $1.08 on the week to $16.18, with about 1/2 of the weekly net move on Friday.
CANADIAN EQUITIES: The TSE 300 was virtually unchanged on the week after recovering from an early week decline of 2.4 percent. Small cap stocks, as described by the TSE 200 fell by 1.2 percent on the week while the TSE 100 rose by 1.2 percent. The gold sector fell by 3.9 percent in line with the price of gold while metals and minerals declined by 1.8 percent. Financial services managed a 0.7 percent gain while consumer products led the pack with an advance of 2.7 percent.
CANADIAN DOLLAR: Despite a negligible net gain on the week, CAD remains in a technical downtrend. Late-week strength was capped at 1.4286 which represents the bottom of the current trading channel. At mid-week, domestic money market rates appeared poised for a Bank of Canada rate increase and this contributed to the currency’s moderate gains from early week levels. The range on the week stood at 1.4286 to 1.4415 with a close of 1.4340 versus 1.4354 last week. Technically, it is bearish that CAD was stopped at the 1.4286 level.
As indicated in the above chart and as discussed last week, CAD is getting close to retracing 62 percent of its rally from late-January, so any weakness beyond 1.4500 will most likely signal a full retracement target in the 1.4700 range. Hence, we could be on the verge of some interesting times on the currency front. I continue to doubt the scope for much drama ahead however, and expect the market to settle sideways as it awaits details of the semi-annual Bank of Canada Monetary Policy report, due May 13.
CANADIAN BONDS:There has been a return to the traditional 25 basis point spread between the Bank Rate and three month Treasury Bill yields during the past couple of weeks as the market is at least a little bit worried about a Bank of Canada tightening in response to a weak currency. The actual slope of the money market curve from 3 to 12 months flattened by 7 basis points during the past week which does not suggest a legitimate market concern about higher interest rates any time soon. The February GDP gain of 0.9 percent, reported Thursday, merely unwound the 0.8 percent, ice storm-related decline in January, so Q1 as a whole is not showing particularly robust growth. In short, Canada does not need higher interest rates, period.
May 4, 1998
FIRST QUARTILE ECONOMICS |
Capital
Markets Weekly Archives
Back to Markets Page
Back to Investors' Corner
Back to The Investment Strategy Page 
The Financial Pipeline Homepage