NORTH AMERICAN & INTERNATIONAL ECONOMIC HIGHLIGHTS

The unthinkable is happening. Bear Stearns, the fifth-largest investment bank in the US received a bailout
today by the U.S. government. The New York Fed will allow investment bank JPMorgan to borrow funds from
the Fed's discount window and re-loan them to Bear Stearns under a secured loan for 28 days.
This is an illustration of how concerned the Fed is about the
credit crunch situation and its potential impact on the
financial system. But when it comes to overall mortgage
write-downs we are only half way through. So the Fed will
continue to try to help as much as it can by providing
liquidity and cutting rates. Therefore, look for the Fed to cut
the fed funds rate by additional 75 basis points in the
coming few weeks. Note that the current easing cycle by
the Fed is by far the most aggressive one in the post-war era
(chart).
While at this point the Fed and the market are not worrying
too much about inflation (especially after today’s market
pleasing inflation figures), there is a significant risk that
inflation will start rising rapidly by year-end and into 2009
due to the cumulative impact of the current monetary
easing, the beginning of a recovery in the US economy and rising food and energy prices. This combination can
take inflation in 2009 to levels not seen in years.
In fact, market-based inflation expectations have increased significantly over the past several weeks. As
measured by the five-year forward five-year breakeven rate, inflation expectations are at 2.8%, which is well
above their 2006-2007 average of 2.45%, and are at their highest since 2004. As well, the yield on five-year
treasury inflation protected security is close to negative territory. This implied higher expected inflation and that
the Fed may be underestimating inflationary pressures.
The Bank of Canada is also not taking any chances and is likely to cut by another 50 basis points in its next
move. While the strong Canadian dollar is clearly helping the inflation situation in Canada,the likelihood is that
by 2009, inflation will be notably higher as the economy recovers and oil and food prices remain elevated.
Granted, it is difficult to think about inflation in the midst of a financial market crisis. But if the story of 2008 is

of a recession/slowdown, subprime losses and lower interest rates, the story of 2009 will be of accelerating
inflation and higher interest rates.