The Canadian Press

Two American economic reports coming out this week could set the tone for early 2010 trading.

Both the Institute for Supply Management’s manufacturing index and the American non-farm payrolls report are expected to show that the U.S. economy is improving.

“The interesting question is: does the U.S. break a long streak of job losses, does it finally go positive or does it need a bit more work to do?” said Colin Cieszynski, market analyst at CMC Markets Canada.

However, if they’re positive, these reports could stoke worries that the U.S. Federal Reserve is going to have to hike interest rates sooner than thought.

The TSX main index ended last week down slightly — but it ran up a stunning 31%” during 2009.

“We have had a substantial recovery and I think what is amazing is people look at these year-end numbers, the TSX up 31%”, and that in itself is huge for a year,” said Andrew Pyle, investment adviser with ScotiaMcLeod in Peterborough, Ont.

He added it’s all the more amazing considering the TSX has surged about 50%” since the lows of early March when investors feared a financial sector collapse.

“But people have to get it in their minds that this is typically something that’s not going to continue the same way for the next six or nine months, and that there will probably be some speed bumps along the way, which is not bad. But these visions of getting everything back by March 9, 2010 may be a tad unrealistic.”

On the first day of the week — and the first trading day of 2010 — investors will take in the ISM report, which is expected to show expansion in the manufacturing sector to the 54.1 level, up sharply from 48.7 in November.

And economists are forecasting a flat showing in the jobs lost/gained column for December after the U.S. economy lost just 11,000 jobs during November, a far cry from the hundreds of thousands of jobs that were being cut on a monthly basis earlier in 2009.

“But the ironic thing is that the good news could be the catalyst for what ultimately upsets this market,” said Pyle.

“And that is if that good news is seen as opening a door to higher interest rates, whether it’s official rates by central banks or just simply in terms of bond yields and mortgage rates, then that’s something that can upset the apple cart as we go through the first few months of next year.”

Analysts have been forecasting that the Federal Reserve won’t raise rates from near zero until much later in 2010.

But Pyle points out that U.S. government Treasury yields went up all during December, sparked by the November jobs report that raised hopes the worst of the job losses were over — and that the economy might even start adding jobs earlier than thought.

“We have seen in the last month a substantial jump in interest rates here and in the U.S.,” said Pyle.

He observed that the 10-year U.S. Treasury yield is approaching four” again, a level that can make investors believe that the fixed income market is a less volatile and equally rewarding place to invest compared to the stock market.

Short-term yields are also rising, with the U.S. two-year bond at around 1.15”, up sharply from below 0.7” at the beginning of December.

“So they’re building in this trend for employment and if that trend is accurate, then that has implications for the Fed,” added Pyle.

“I don’t think the analysts are correct in thinking we can go through an entire 12 months without seeing a rate hike by the Fed if these numbers continue. And the bond market is saying, ‘We definitely don’t believe that, we think if anything we may be surprised in how early the Fed may go on interest rates because they have to account for this.’ ”