By Carl Gewirtz

Published: October 30, 1995

PARIS Warning: Be prepared for a volatile week in all financial markets.

The major source of potential instability is Monday’s referendum on Quebec independence, which the latest opinion polls show is too close to call.

Although the Canadian dollar and Canadian bonds have weakened in the run-up to the vote, bankers expect major sell-offs if independence is approved. What is more, some analysts fear a chain reaction engulfing U.S. markets because upsets in Canada and signs of renewed troubles in Mexico would threaten a new and heavy blow to U.S. export prospects.

A no vote on independence would give a definite boost to Canadian markets and permit the U.S. market to bask in the glow of last week’s data showing solid economic growth with little inflation.

The favorable data coupled with reduced strains within Europe helped buoy the dollar on the foreign-exchange market last week, but traders said activity remained thin.

Major exporters in Germany and Japan are now believed to have covered their needs to convert into local currency for the rest of the year during the dollar’s rally between mid-August and early September, and portfolio investors are reported to be on the sidelines awaiting resolution of the budget-cutting struggle between President Bill Clinton’s administration and Congress before moving into the dollar.

In Europe, currency tensions have eased. The French franc rose 1.2 percent against the Deutsche mark after President Jacques Chirac’s pledge to give priority to cutting the budget deficit. The mark ended at 3.4748 francs in New York on Friday, down from 3.5160 francs the previous week.

French bonds also rallied sharply on the prospect that renewed confidence in the currency would pave the way for the Bank of France to lower interest rates.

But French analysts warned that the currency was not yet out of danger. The government has bought itself some time, one dealer remarked, to detail planned spending cuts in social security which are to be announced Nov. 14. If the package fails to convince, he added, the pressure on the currency would resume.

Italy also won a reprieve when Prime Minister Lamberto Dini faced down a no-confidence vote. The lira gained 1.4 percent against the mark and bond prices also rallied. The mark fell to 1,134.54 lire Friday from 1,150.54 lire a week ago.

In the international bond market, activity is thin and institutional investors are playing second fiddle to retail clients. Surprisingly, at a time when Japanese institutional investors are looking to pare down foreign exposure because of their borrowing difficulties, retail demand appears to be stronger than ever and growing.

Japan’s low interest rates of 1.6 percent at five years and 2.6 percent at 10 years are driving individual investors to look offshore for better returns. Yamaichi Securities Co. last week managed $200 million of three-year notes from the World Bank targeted to domestic retail clients. The paper was priced at a discount to yield 5.4 percent paid semi-annually an all-in cost to the borrower of a narrow four basis points over U.S. government rates.

Yamaichi executives said Japanese retail demand also was behind Ontario’s sale of 600 million Australian dollars ($453 million) yielding 7.3 percent semi-annually.

Ford’s $1 billion of five-year notes also sold heavily into Japan. Goldman, Sachs & Co.estimated that 45 percent of the global issue was sold outside the United States with half of that in Asia, of which two-thirds was in Japan. Swiss retail investors also are buying,and with retail clients less demanding than professional investors, rarely seen U.S. issuers like Coca-Cola Co. and Wal-Mart Stores Inc. also tapped the market, raising money at terms slightly cheaper than would have been possible in New York.

Frankfurt bankers estimated that 40 percent of the jumbo 2 billion Deutsche mark ($1.43 billion) issue from the European Investment Bank was sold into Japan. Its seven-year notes were priced to yield a mere six basis points over German government rates. A month ago, the World Bank paid a spread of nine basis points over the government benchmark to issue 3 billion DM of seven-year notes.

This week, Greece is expected to tap the floating-rate market for up to 750 million DM and Colombia and Venezuela are looking to tap the Deutsche mark sector.

In the dollar market, the Tennessee Valley Authority which only four months ago made its debut on the international market is to return with a new global issue split between $1 billion of five-year notes, expected to yield 19 basis points over government paper, and $500 million of 30-year bonds at an expected spread of 35 to 40 basis points. The 30-year bonds are not expected to find much of an audience outside the United States.