Dollar And Risk Tied To Stress Tests, Fed Forecasts

Investor confidence in the US and across the globe remains in limbo. The market is waiting for an indisputable sign that growth and rates of return are nearing a turning point; but so far, the weight of recession and lingering financial troubles hasn’t let up.

[B]The Economy And The Credit Market[/B]

         Investor confidence in the US and across the globe remains in limbo. The market is waiting for an indisputable sign that growth and rates of return are nearing a turning point; but so far, the weight of recession and lingering financial troubles hasn’t let up. However, in the meantime, fear that further financial seizures are just around the corner (a high probability risk just six months ago) has encouraged capital to find its way back into the capital markets from risk-free assets like Treasuries and money market accounts. Looking ahead, there are a few major events that could alter the market’s perception of risk: more optimistic economic forecasts from policy makers and the outcome of the first quarter earnings season. Today, the Fed released its Beige Book with the usual grim assessments. But, this time around there were a few bright spots hinting to the inevitable recovery. Whereas, a return to growth may be a long ways off, the appraisal of business health is active and ongoing. Particular interest will be paid to the revenues of the large US banks - who have so far bested expectations and raised the outlook for the Fed’s ‘stress tests.’

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[B]A Closer Look At Financial And Consumer Conditions[/B]

         Market operations and confidence continue to improve. Though demand for short-term Treasuries and relatively risk-free money market paper holds stubbornly to recent record highs, there has been clear interest in reinvesting into the more speculative areas of the financial markets. The more time that passes since the last credit market seizure, the more likely it is that the financial crisis has passed. There are still milestones to risk going forward. In the US, the government’s ‘stress tests’ loom. While this evaluation of health for the nation’s 19 largest banks will be backed by infusions of capital for those struggling, investors will nonetheless take it as a vote of confidence.

                                   

         

         

         

         The world’s largest economy has yet to mark the worst of its economic recession. Today, the Federal Reserve’s Beige Book painted a dreary (yet unsurprising) picture of activity. Among the highlights, from the economic paper used by FOMC members to determine monetary policy, was a “generally bleak” outlook for employment, warnings that manufacturing shrank nationwide, “weak” consumer spending and altogether signs that national growth was still contracting. However, there were also preliminary signs of improvement. Housing was showing a few signs of stability. More remarkable, the report said 5 of the nation’s 12 Fed districts’ reported contractions were easing. 

[B]The Financial And Capital Markets[/B]

         Capital markets have maintained their broad recovery; but price action seems to be outpacing sentiment. US equities have recovered nearly 20 percent since hitting their decade lows over a month and a half ago; physical commodities have reversed course after months of basing; and risk premiums in debt and derivative markets have shrank. However, despite these improvements, positive growth is still a distant hope and financial uncertainties still very real threats. Policy officials, economists and traders unanimously forecast an eventual recovery in global expansion sometime either later this year or through the first half of 2010. However, whereas politicians and academics can afford to have a long-term outlook, market participants cannot. An ongoing recession dampens rates of return, stifles capital investment and puts the breaks on production. Altogether, the economic hardship is the fuel for a bear market – so how stable is this ‘market recovery?’

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[B]A Closer Look At Market Conditions[/B]

         Over the past week, capital markets struggled to keep the momentum behind the developing rebound from late February lows. The Dow has struggled to keep its pace following its push through 8,000 as last week’s drop in liquidity preceded the start of earnings’ season. With most economic parties forecasting a sharper pace of contraction through the first quarter (not much of a stretch considering the horrible monthly data that has crossed the wires), investors are looking for see how revenues fared. This could act as justification or a contradiction to the fragile rebound in investor optimism. Commodities have responded with greater caution with demand wholly in flux.

                                   

         

         

         In gauging the health of the markets, we have to balance the health of risk and return. For a genuine recovery to develop, investors need to see real evidence for a returns to grow and encourage competition amongst investment classes; and they have to be able to comfortably assume there are no major threats to the normal functioning of the markets. In the recent rebound in price action we have been seeing, the development has been completely on the side of risk. It has been months since a major bank or industry has teetered on the edge of collapse (and threatened the credit market), which is allowing for equity in the absence of panic. Without growth, though, this advance may fail.

[I]Questions? Comments? Send them to John at <[email protected]>. [/I]