FIRST QUARTILE ECONOMICS

Capital Markets Review

Monday, July 6, 1998

CANADIAN DOLLAR: The currency has settled into a somewhat dormant state in the past couple of weeks. After touching record lows in mid-June, the CAD has stabilized but not really shown any signs of rebound. Technically, in terms of chart patterns, the currency did bounce of support in the 1.4750 area recently and despite general concern that the Bank of Canada would have to raise interest rates to stabilize the dollar, this has not yet been necessary.

In reality, the recent new lows have been somewhat marginal which probably has to do with the moderate negative Canada/U.S. yield spreads now in place versus the much wider spreads several months ago. All this is a favorable sign as it suggests the next Bank of Canada interest rate increase will further diminish the scope for future CAD weakness. In reality, the domestic economy does not particularly need higher interest rates and it is a positive of sorts that the Bank still has the flexibility to act in accordance with domestic economic fundamentals.

U.S. DOLLAR: The dollar of late has been bounced around by developments in Japan. The recent U.S. intervention failed to have a lasting dampening impact on the dollar and by last week a full recovery to pre-intervention levels had occurred. More recently, focus is on the so called Japanese Bridge Bank and other steps to bolster Japanese economic recovery. So far, the dollar has not cooled off enough against the Yen to suggest a meaningful positive verdict on the Japanese measures. This in turn suggests it is only a matter of time before the Yen resumes its decline.

U.S. BONDS: The scenario is positive for bonds. The FOMC meeting passed with no change in Fed policy and more and more observers believe Asia will keep the Fed in a steady policy mode for the balance of the year. Economic data have also been supportive as the June NAPM (Purchasing Managers’ Index fell below 50 for the first time in a couple of years) and June unemployment rose a notch to 4.5%. The U.S. yield curve is inverted from 2 to 10 years and the only yield above the 5.50% Fed Funds rate is the 30-year Treasury at 5.60%. This inversion implies an eventual full inversion which at current yield takes the 30-year to at least 5.40%. Despite apparent concern over future Fed policy and tight labor markets, this environment suggests the bets are on contained inflation.

July 6, 1998.

By Frank Hracs -First Quartile Economics

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