Investors were bombarded with a lot of information this week from economic data, to monetary policy reports, to corporate earnings. While North American markets may be a bit higher this week after five days of trade, we aren’t seeing a great deal of change if we look back at where we were two weeks ago. Perhaps that’s because this week’s data told two different stories.

First, earnings season got into full swing in the United States as a third of the Dow Industrials Index reported earnings, and for the most part corporate earnings have exceeded or met expectations thus far.

Yet again, corporate America has managed to remain profitable on a global scale even though the operating environment has been challenging. With perhaps the exception of Citigroup, most of the U.S. financials that reported had positive reports. More importantly, their results suggested the U.S. financial system is slowly improving.

While U.S. earnings provided positive headlines, economic data was disappointing. Manufacturing data, retail sales, housing starts & sentiment, industrial production and initial jobless claims were all worse than expected. In some cases the data was actually positive, but just not as positive as economists had hoped, thus suggesting that the economic momentum seen in the first quarter of 2012 may be slowing for now.

In Canada the economic outlook was much more positive as Bank of Canada Governor Mark Carney kept interest rates unchanged, but provided an outlook for Canada that was better than expected. As such, expectations for rate hikes were brought forward and the Canadian dollar jumped over a cent on the news, only to soften as the week progressed.

Monetary policy expectations must have been the driving force behind Canadian dollar strength as we really didn’t see oil or gold prices change to a large extent. Just like last week, we find prices relatively unchanged as volatility continues to stabilize even as events in Europe, China and corporate America continue to unfold. Speaking of Europe, the Euro managed to strengthen against the U.S. dollar thanks to successful Spanish bond auctions which initially had investors on edge.

SPANISH YIELDS MOVING HIGHER

European sovereign bond yields. Sound familiar? It should since bond yields have been front page news since Greece started its decline into financial fragility more than a few years ago. While Greece may have received a second bailout and is solvent so to speak for the time being, investors are closely watching bond yields, namely 10-year bond yields in a number of European countries as that continent tries to emerge from a very difficult debt crisis.

This week focus turned to Spain in particular as that country had auctions for both 2-year and 10-year bonds. The good news is that demand at those auctions was good enough to take up supply; however, the bad news is that higher yields resulted to get the deals done.

As you can see in our Chart of the Week, Spanish 10-Year bond yields have been on the rise since February as that country continues to deal with double digit unemployment, a horrible real estate market and a government (both new and old) that has been desperately trying to reduce the budgetary deficit by cutting spending and sacrificing growth.

Whether we talk about Greece, Spain, Portugal, Italy, France or Germany, European sovereign bond yields are going to be on the radar screen for many months to come.

TRADING WEEK AHEAD

We hope you fastened your seatbelt for earnings season last week as the number of Q1/12 earnings reports will continue to be fast and furious in the week ahead. For the most part, many of the reports delivered thus far have been positive and equity investors hope that trend will only continue for some of the world’s largest companies.

Last week we had a third of the Dow Industrials Index report and this coming week will see almost another third deliver results including heavyweights 3M Co, AT&T, Boeing, Caterpillar, Exxon Mobil, Procter & Gamble and United Technologies Corp.

Usually reporting season in Canada kicks into gear a couple of weeks after the U.S., but we’ll see results out of a number of large cap companies over the next few days including CN Rail, Teck Resources, Rogers Communications, Potash Corp, Shoppers Drug Mart and TransCanada Corporation.

Canadian monetary policy was in full focus last week, but focus will shift south on Wednesday when the Federal Reserve will announce its most recent interest rate policy decision. We don’t expect any change in interest rates, especially since the Fed has told us it will likely keep rates steady until 2014, so investors will likely focus on the statement that accompanies the decision to see if U.S. central bankers have changed their economic tone. Considering that recent economic data has been worse than expected, we don’t expect their outlook to become increasingly bullish at this stage.

The International Monetary Fund and Finance Ministers from around the world are meeting this weekend as the IMF tries to shore up more financial support to help its efforts in Europe. There were incications today that it will likely be successful, thus adding a bit of strength to the Euro and weakness for the U.S. dollar.

If this trend continues next week, look for commodities to see increased financial demand. We also believe precious metal traders will be focused on the FOMC meeting to see if the Federal Reserve will make any mention of a potential third round of Quantitative Easing (QE3) which would certainly weaken the dollar and send gold prices higher in the short term.

QUESTION OF THE WEEK

Economists noted that commentary from Bank of Canada Governor Mark Carney was more positive than expected this week. Does this mean that interest rates will go up at the next Bank of Canada meeting?

While Mark Carney may have been more bullish than economists thought he would be, we would not interpret his comments to suggest that rates are going to increase immediately. We believe he was simply doing his job by reminding Canadians that the next likely move is one that would see rates go higher in the future.

Friday morning’s core inflation reading of 1.9% would also suggest that rates will not move higher in the immediate future to keep cost increases under control. While we will fully recognize that Mark Carney would love to raise interest rates today (what Central bank Governor wouldn’t when rates are at 1.0%?), we feel he cannot rush to raise rates in the next few months for three main reasons:

  1. the financial crisis in Europe is still ongoing and may not stabilize for some time, thus leaving the financial system vulnerable;
  2. while there is a recovery underway in the United States it remains slow and sluggish for our largest trading partner; and
  3. a slowdown in global economic growth has resulted in some softness in the Chinese economy which is influential in dictating a number of commodity prices.

While we don’t believe the Chinese economy is vulnerable to a material decline in GDP this year, we will recognize that any softness from that market has a significant impact on commodity demand.

So, while Mr. Carney would love to pull the trigger and raise rates as soon as possible in order to prepare Canada for any future economic difficulty, we also believe he will be patient enough to recognize that various economies to which we are sensitive need more time to stabilize and grow on a more sustainable level. It is likely that rates will move higher in the next 12 months in this country, but not likely at all in the next 12 days.


Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends.
@Gareth_RGMP