FIRST QUARTILE ECONOMICS |
I detected in this semi-annual report a somewhat less ominous monetary tightening scenario ahead than seemed to be the case from the Bank of Canada's rhetoric just a couple of months ago. The Bank indicated that it seemed likely that further action to reduce monetary stimulus will be required between now and the next semi-annual report in six months. The Bank indicated the Canadian dollar's current softness was temporary and this reinforces my view that the Bank will not defend the currency with higher interest rates. This also suggests the C$ will remain relatively soft versus the U.S. currency for some time. With the September Merchandise Trade Surplus falling to $869 million from $1.2 billion in August and $1.6 billion in July, the last thing we need right now is steps to boost the Canadian dollar!
I think that this means the Bank will raise the Bank Rate early in the new year and probably three months later around April. Money market rates will have been raised 100 basis points from their lows (50 basis points have already occurred in 1997) and we'll see where the economy really stands at that time. My outlook is for a relatively imminent descent to the 3 % GDP range which keeps a decent output gap in place . I don't think the central bank is currently building in much of an impact from Asian economic events but then again they would probably be viewed as alarmist if they did.
The U.S. data this past week were favorable on the inflation front as the CPI for October is now up 2.1 % yr/yr and the core CPI is up 2.3 % yr/yr. I still expect a yr/yr level around 1.7 % in a few months and if the Asian deflation thing begins to show up soon , the CPI could be hitting 1.5 percent by the Spring. Fed Chairman Greenspan has recently reminded everyone he still thinks the CPI overstates the level of inflation in the country even after recent and upcoming refinements. So, I remain positive on U.S. bonds and expect a near term break of the 6% level on 30 year Treasuries.
I really don't know what the next Fed move is going to be but I feel strongly the Fed will do nothing for several months. With a big part of the world expecting the U.S. to be the "importer of last resort" in 1998, it borders on recklessness for the Fed to indicate that the time has come to crush wage pressures via higher short-term interest rates.
Next week has the U.S. Thanksgiving holiday and financial market activity will be of a "holiday-thinned" mode. The IMF bailout of South Korea should be further clarified and equity markets now at least feel better after some good rebounds in the past week.
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