Income Strategy October 26, 2007:

The North American bond markets are signaling a belief that the US economy is slowing faster than predicted. The housing sector is continuing to cause havoc all across the country as prices fall and foreclosures rise. The fall out is hitting many areas of the economy Merrill Lynch just reported a write down of $8.4 billion related to subprime mortgages and other products.

The widely held belief that the US economy will be slower than first forecast due to the tightening credit conditions is having a negative impact on the US dollar which is losing ground to all major currencies. The Canadian dollar touched $1.0413 today and closed at $1.0395. The market commentators are all a buzz with talk of new all time highs over the next few weeks and there are some very bullish analysts out there calling for wildly higher prices. I think the recent surge in the Canadian dollar is likely a little over done and would not be surprised to see it fall back 3 or 4 cents over the next few weeks and then trade in the $1.00 to $1.05 range for a few months.

It appears likely that the US Federal Reserve will lower interest rates when they meet next week. The question is by how much, I think 25 basis points will be all that is required but there are many who are looking for another 50 basis point reduction in order to save the stressed financial sector.

I am glad that I am not Mr. Bernanke who will have to explain and justify any change to the American public and politicians who have very different opinions on who should be bailed out by the Federal Reserve.

The Bank of Canada on the other hand is likely to leave rates unchanged for quite some time allowing the higher Canadian dollar to do most of the work required to bring inflation under control. David Dodge the Governor of the Bank is not pulling any punches when he tells Canadians to shop with their feet. If Canadian retailers won’t reduce the prices as the dollar rises then cross the border to shop that will force the price reductions and reduce inflation at the consumer level.