FIRST QUARTILE ECONOMICS |
There was also plenty of official talk in Japan this past week that the economy was fragile and that interest rates are not going up anytime soon. This is bad news for the Yen as it opens the door for renewed depreciation against European and North American currencies . Of course , such depreciation is necessary for the Japanese economy to absorb the adverse macro-economic impact of struggling Asian trading partners.
For the rest of the world, there is a disinflationary lining in Asia's woes that must somehow be a positive for fixed income markets . Whether interest rates go up less than they otherwise would or whether an eventual rise is delayed , the broad risk of resurgent inflation in the U.S. in particular remains low. The U.S. economic data were essentially bearish for fixed income markets this past week as there was a 2 point rise in the October Purchasing Managers' Index while the October employment report gave no support to the thesis of an emerging moderation in GDP growth. Payroll employment advanced by 284,000 jobs with manufacturing jobs up a significant 54,000 . Unemployment fell to 4.7 % and average hourly earnings rose by 0.5%.
These data point to solid industrial production growth in October while the yr/yr gain in hourly earnings posted a 4.2 % gain versus 3.6 % in September. Nevertheless, there is no broad expectation of tighter U.S. monetary policy soon. Next week's FOMC meeting on Nov 12 is generally expected to result in no change in the 5.50 % Fed Funds rate. I also doubt the Fed would raise interest rates at the next meeting just before Christmas .
The key remains inflation. As long as inflation shows no sign of reaction to tight labor markets, the Fed should remain on hold but continue to talk tough about the looming risks of inflation and corresponding tighter monetary policy. In the past, this would normally have been a disaster for bonds but longer term interest rates are not behaving as if there is a fundamental inflation problem on the horizon. This has got to be because the current 2% inflation rate is increasingly being viewed as the long term norm . The next recession or soft landing will consolidate the 2% level if not result in even lower inflation . Against this background , interest rates still appear on the high side.
For Canada, the breakdown of the Canadian dollar has not reversed and the trading community is obsessed with the timing of the next Bank Rate increase. The October employment report has also confused the picture as unemployment rose a notch to 9.1 % and employment was stagnant for the second straight month . This may indicate a break in economic momentum is developing that means the Bank of Canada might not have to raise interest rates as much as generally expected over the next year (perhaps 50 to 100 basis points had been expected). I am not a big believer that the Bank of Canada will raise interest rates to strengthen the currency . Only if there is some kind of run on the dollar that develops significant momentum would such a move occur. If anything, Canada needs a softer currency at present to work against the relapse of the trade surplus during the past year . Over the next several months , I expect lower U.S. inflation will push long Treasury yields toward their 1993 low of 5.75 % . Long Canada yields will follow closely .
Friday, November 7, 1997.
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