Bad Omens

For quite some time there have been bad omens to cause us concern about the economy.

Weak commodity prices have a great deal of relevance for our economy, where they are so important for our exports.

The economy in North America can be described as sluggish at best with GDP expanding at about one per cent. Corporate profits have gained only slightly this past year overall, but those associated with oil prices have fallen significantly.

Perhaps the biggest immediate worry is rising bond prices, that is higher interest rates, which of course, reflect dwindling liquidity-cash available. After all, it is money that makes the world go around.

All this is taking place before central banks – the U.S. Federal Reserve and our Bank of Canada – have started to raise interest rates.

Interest rates in North America are close to zero. That has entailed speculation in housing, something that Canada recently cited as a matter of concern. People have been purchasing very expensive, over-priced homes because with very low interest rates, the carrying charges are not onerous. What happens next when the government inevitably raises interest rates?

The spreads – the difference the interest rates paid by governments and the leading blue-chip companies – reflects the risks of defaults. Rising interest rates are caused by threats of default. That simply suggests that investors worry about getting repaid.  That relates to anxiety about the economy.

Rising interest rates often have been harbingers of a business recession. That is not entirely reliable, but it cannot be ignored. Thus, banks have reduced their market-making activity. That can lead to sharp price moves as investors become more cautious and a kind of buyers’ strike ensues. The fall in commodity prices adds to buyers’ worries.

The cycle of a credit driven boom and bust is very important and has manifested itself over and over again.  The cycle goes on pushing up prices. 

These trends feed on themselves and buyers become ever more enthusiastic. Demands for credit rise as more want to participate in the cycle. Rising interest rates seem to confirm this. These worries may be overdone as cash reserves are large.

Still yellow lights are flashing but many hope that calm will continue for some time yet.



Bruce Whitestone