Chinese Interest Rates - Movin' On Up!

Chinese Interest Rates – Movin’ On Up!
Gareth Watson, CFA - Vice President, Investment Management and Research, Richardson GMP

With little economic data being released in North America this week, investors turned their attention to corporate earnings, especially in Canada where the rate of reporting picked up steam. Overall, corporate North America has done a reasonable job in meeting consensus expectations. It appeared by mid-week that the impact of political tensions in Egypt may be waning, but that certainly changed over the past 24 hours which saw President Hosni Mubarak insist on retaining his Presidency only to relinquish it half a day later. This event was important for Canadian markets as the recent crude oil risk premium started to decline, pushing oil prices back below US$90.00 per barrel to the mid US$80 range. Even with that decline the TSX Index came very close to breaking even for the week as any energy related weakness was offset by strength from the Canadian banks.

Another big event was China’s decision to raise interest rates by 25 bps for a second time in just over a month. Initially this move did spook markets, but those fears were quickly shrugged off as markets moved higher. The great China inflation debate continues with bulls noting that rate hikes are required to keep China’s growth rate intact, while the bears will argue that this could be the first of many rate hikes to come, thus lowering China’s growth prospects. The Chinese government has a reasonable track record of keeping its economy in line, and market reaction this week would indicate that most investors believe future rate hikes will be controlled, keeping Chinese inflation in check.

Other than the fluctuations we saw in the energy markets, there weren’t any dramatic movements in other commodities this week as the U.S. trade weighted dollar was only marginally higher by Friday. A higher U.S. dollar and falling oil prices are never a good sign for the Canadian dollar; however, the events in Egypt on Friday had investors feeling a little better, thus resulting in U.S. dollar selling and allowing the Canadian dollar to basically break even by week’s end.

What is Supporting Gold?

Is this the time of year to buy gold? Most seasonal investors would say no since physical demand from the Indian sub continent is normally at its highest from September to December. So why haven’t we seen a seasonal sell off yet? It’s quite possible the answer is tied to the outlook for the U.S. dollar which is driven by monetary policy. Other than seasonal factors, gold was helped last year as soon as the first Quantitative Easing 2 (QE2) rumours began in August, while the recent bounce coincided with Ben Bernanke reaffirming the Federal Reserve’s commitment to QE2. As long as the Fed continues to weaken the U.S. dollar, without publicly admitting it, by flooding the U.S. economy with money it probably doesn’t need, gold prices should find some reasonable support from the market place.

The Trading Week Ahead
Earnings in Canada will continue to be released next week as more and more large cap, blue chip names will release their Q4/2010 earnings reports. On deck in Canada, we’ll hear from gold heavyweights Barrick and Kinross; energy large caps Husky and Talisman; pipeline behemoth TransCanada Corp; along with Rogers Communications and Sun Life Financial. While the economic data out of the U.S. may be light next week, the prints we’ll see could be influential as the U.S. recovery depends on employment, consumer spending and housing prices. Advance retail sales will let us know how well the retail sector has held up since the holiday season, although results may be adversely affected by bad weather in the U.S. northeast, while housing starts might only reaffirm what we know – that the U.S. housing market has struggled and will continue to struggle. Inflation could be a non event as expected yearover-year growth rates are well within the ranges where both the Federal Reserve and the Bank of Canada want them to be. Ben Bernanke will be making a couple of prepared comments in front of Congress and in France. While it’s unlikely he will reveal anything new that would move the markets, U.S. dollar watchers will be paying attention to make sure there has been no change in view with respect to quantitative easing. And even though President Mubarak has resigned, investors will still be keeping their eyes on Egypt to make sure that any political transition is a smooth one and the economic gateway, known as the Suez Canal, is open for business.

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