FIRST QUARTILE ECONOMICS |
INTERNATIONAL EQUITIES: The S+P 500 rose by 0.2 percent on the week and despite all the recent volatility is down a mere 2.85 percent from its peak. The Dow on the other hand had a faster run-up and has given up 5.9 percent from its peak. The Dow fell by 1.4 percent on the week while the NASDAQ rose a decent 2.1 percent.
Latest talk from the earnings estimate people is that Q2 earnings are projected to post a yr/yr gain of 4 percent which is down from expectations of 5 percent just a week ago. With Q1 earnings up an actual 3.8 percent yr/yr it seems increasingly unlikely the year-end expectation of 8.9 percent will be achieved and another potential blow to equity prices may still lie ahead.
In Asia, the currency intervention was just what the doctor ordered as the Japanese equity market rose a net 1.6 percent after nearly testing long term support that has held up on three prior occasions in the 1990s. Hong Kong rose a stunning 8.5 percent on the week and a simply spectacular 16.0 percent from its early-week low to its weekly close. This is reminiscent of the early 1998 recovery which ultimately proved premature.
U.S. DOLLAR: The dollar finally hit enough raw nerves in Asia and elsewhere this past week and the Fed initiated a Yen support effort on Wednesday. Compared to the recent wasted efforts by the Bank of Japan, the results this time were awesome, at least temporarily. From an early week high of 146.75 Yen, the dollar closed the week at 137.08 Yen and traded as low as 133.85. With speculation Hong Kong was on the verge of abandoning its peg to the USD and China threatening devaluation, something had to be done to prevent undue financial market repercussions in the U.S. It appears the U.S. may have won some concessions from Japan in terms of speeding up reform and revitalizing the Japanese economy. Still, all the basic problems remain.
Notice the lack of intervention support from any other country as the U.S. appears to be taking a disproportionate responsibility for global economic and financial market stability. While there may be a more coherent global foreign exchange stance following the current G7 meetings, few are counting on such a thing just yet. As the Yen rallied the DM held pretty steady with a weekly trading range of 1.7805 to 1.8170, and a close of 1.7890 versus 1.8056 last week.
Looking ahead, it is merely a matter of time before the Fed is tested by the market. If the market can digest a $20 billion plus intervention by the BoJ several weeks ago with no lasting net impact on the Yen, a mere $6 billion or so estimated to have been spent by the Fed is not going to have a lasting impact either. Another way of looking at the situation is to decide if this is the equivalent of the U.S. dollar turnaround that was engineered three years ago. Not likely. At best this is buying time in an attempt to brake the momentum of a falling Yen. Further intervention may amount to the equivalent of pouring money down the proverbial rat hole, which means the more definitive “crisis” (requiring global intervention) may still lie ahead.
U.S. BONDS: Long Treasury yields hit new record lows in the flight to quality on Monday, closing at 5.58 percent before rising to 5.75 percent after the dollar reversal. Long Treasuries then closed the week at 5.67 percent virtually net unchanged on the week.
The dollar scenario is obviously quite significant to the outlook for U.S. interest rates but it is not easy to draw a coherent picture of just how. At first blush, a weaker dollar is a notional negative for bonds, however so far the Yen is only back to levels of a few weeks ago and effectively spent little time in the 140 area. Secondly, the progressive rise of the dollar is viewed as a significant contributor to the tame U.S. inflation environment in recent years and any change in that trend is a negative for bonds. Thirdly, the fierce rebound in gold prices during the past week is inconsistent with a positive bond market as is the rebound in the CRB Index. Accordingly, if the past week marked an ultimate peak in the USD and a potentially long downtrend is truly at hand, it is more difficult to remain constructive on the U.S. bond market.
But there are other ways of sizing up the outlook. First of all, Japan’s recession is six months old but nothing is in place to trigger the beginning of recovery of any kind before sometime in 1999. Other things being equal, the rest of Asia is on its own in terms of working through the miscellaneous recessions now underway. Commodity prices therefore have no basis to sustainably recover any time soon. Gold prices may have achieved a double bottom during the past week but the fundamentals for sustainable recovery remain unimpressive. Secondly, whether the recent currency intervention is enough to do the job or if more will soon be necessary, the U.S. intervention signals a policy commitment to not making the global economic and financial environment any worse. That would include an indefinite deferral of tighter Fed policy along the lines of the Mexican currency crisis in late-1994/early-1995. If indeed the economic impact on the U.S. from weak Asian economies is still largely ahead, the case for an indefinite period of unchanged Fed policy remains sound and credible.
For bonds, this remains a constructive environment and while there was certainly a meaningful profit taking shock at mid-week, the market’s significant retracement to close the week suggests the betting is on the status quo Fed scenario above.
CANADIAN EQUITIES: The TSE 300 declined by 2.2 percent this past week and now stands 8.7 percent below its recent peak. Utilities led the decline with a fall of 5.2 percent and were followed closely by industrial products which fell 4.3 percent. Golds led the winners with a gain of 2.1 percent reflecting the 4.5 percent gain in gold prices.
CANADIAN DOLLAR: New lows were set for the CAD this past week and it seems likely the downward momentum will not stabilize until the Bank of Canada raises the Bank Rate. This week’s trading range stood at 1.4592 to 1.4767 with a close of 1.4710 versus 1.4675 last week. To be fair, the extreme of the CAD weakness was tied to the corresponding plunge in the Yen, gold, oil and commodity prices generally, factors which the Bank may not have felt could be meaningfully offset by an increased Bank Rate. However, as the Yen recovered along with gold and the CRB Index, the Canadian dollar has barely stabilized near its record lows. In other words, the CAD appears to have little fundamental basis to launch a meaningful recovery until some interest rate support materializes.
Technically, the story is a bit more in favor of the currency as major trend channel support exists in the 1.4760 area which essentially held this past week. If CAD fails to set another record low over the next several trading sessions, this technical reference point will have taken on greater validity and there will be room for at least some rebound in the currency.
However, it is only a matter of time before the market specifically tests the Bank of Canada’s tolerance for the newly accommodative degree of monetary conditions which appear out of line with the tone of the Canadian economy generally. The Monetary Conditions Index has posted the interest rate equivalent of a 100 basis point decline since mid-March and has only tightened the equivalent of 40 basis points since the first Bank Rate increase one year ago. If the MCI means anything at all, it is hard to believe the Bank is content with its current stance.
CANADIAN BONDS: Domestic short rates are now making some allowance for a near term rise in the Bank Rate amidst the persistent phase of Canadian dollar erosion. Long rates, however, continue to move in tandem with their U.S. counterparts and the overall domestic yield curve has flattened further.
On the data front, the May CPI was up an uncharacteristically strong 0.3 percent while the yr/yr trend rose to 1.1 percent from 0.8 percent the previous month. Ultimately, few market participants are worried about an imminent inflation problem and rightfully took the inflation data in stride on Friday.
From a technical perspective, 30-year Canada yields have room to move toward the 5.25 percent area before channel resistance sets in just as it did recently at the 5.55 percent range. Canada/U.S. long term yield spreads may also have been expected to widen out amid Canadian dollar softness but have so far successfully tested channel support.
June 22, 1998
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