Credit markets have experienced incredible volatility and met new lows over the past week as scheduled and unscheduled event risk shook already unstable investor confidence. Before the end of last week, genuine fear began to take hold of the market. On Friday, a report that Bear Stearns was on the verge of collapse and was forced to seek emergency lending from the Fed brought the freeze in lending and tumble in financial markets to a new level. Default premiums soared and short-term lending rates plummeted as traders abandoned risk for liquidity. After the weekend, policy officials once again went to work trying to advert a financial crisis.
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[B]CREDIT MARKET: HOW IS IT DOING?[/B]
Credit markets have experienced incredible volatility and met new lows over the past week as scheduled and unscheduled event risk shook already unstable investor confidence. Before the end of last week, genuine fear began to take hold of the market. On Friday, a report that Bear Stearns was on the verge of collapse and was forced to seek emergency lending from the Fed brought the freeze in lending and tumble in financial markets to a new level. Default premiums soared and short-term lending rates plummeted as traders abandoned risk for liquidity. After the weekend, policy officials once again went to work trying to advert a financial crisis. First, the Fed pushed Bear into a deeply discounted sale to JP Morgan to assure the market of its solvency. Then, on Tuesday, the FOMC cut the Fed Funds and discount rates another 75 basis points.
[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
Risk premium in the debt markets continues to rise. This past week was particularly brutal for insuring debt against default. Bear Sterns’s near bankruptcy was a glaring sign to the market that even the venerable firms could fall under current market conditions. And, while default swaps have pulled back since the Fed’s bailout and rate cut, interest in investment grade debt has been slow to rebound. Demand for liquidity was still the primary drive for investors over the past week. After news of the Fed’s bail out of Bear Stearns hit the wires, the benchmark three-month Treasury bill rate plunged to its lowest level in 50 years. However, since the investment firm’s sale and the easing in monetary policy, the flow into short-term debt has yet to ebb. This hesitancy may reveal the financial market’s true lack of appetite for risk.
[B]STOCK MARKET: HOW IS IT DOING?[/B]
Equity markets were brought back from the brink this past week. The benchmark Dow was pushing back below 12,000 by Friday. While a new 16-year low in consumer sentiment helped to erode the market’s bullish convictions, concern was truly stoked by news of Bear Stearns troubles. While the firm’s near failure had an incredible impact on the financial sector, it would also have its influence on the broader market. When such a renowned company flirts with bankruptcy, not because of a natural market changes but due to problems in basic lending; the outlook for the rest of the corporate world is jeopardized. Proving a greater influence on equity traders though was the Federal Reserve’s 75 basis point rate cut. Though the market was fully prepared for such a deep cut, the belief that the expansionary policy would help revive growth led to the biggest one day rally from the Dow in five years.
[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
The various sectors of the broad stock market were responding differently to this past week’s event risk. The undisputed market mover for the past week was the Financial group, which suffered extreme volatility thanks to the influence the Bear Stearns’ bailout and the central bank’s sharp easing in monetary policy had over the normal functioning of lending and investing. On the other hand, the Fed decision would easily bridge all sectors. With such accommodative lending rates, demand and production may rebound more quickly. With credit markets in turmoil and interest rates in flux, it was difficult to measure the fair value of investment banks and trading houses. Through the end of last week, investors’ primary concern was Bear Stearns’ emergency bailout and sale. This marked the first major institution to succumb to the extremes in credit and financial markets. And, with credit markets nearly frozen, cautious investors have been left to believe that Bear may just be the tip of the iceberg. Analysts are now keeping a close eye on Lehman Brothers and Citibank.
[B]U.S. CONSUMER: HOW ARE THEY DOING?[/B] The consumer was one participant in the economy that would not be immediately influenced by the news of Bear Stearns. Instead, the health of this vital GDP component would fade thanks to the unrelenting downturn in growth. Last week, the economic calendar released disappointing readings of both consumer sentiment and spending. February retail sales dropped 0.6 percent as demand for both discretionary goods and necessities like food and gasoline fell. Further promising to keep spending habits depressed in the months ahead, confidence slipped to a new 16-year low thanks to the unwanted mix of higher living costs, rising unemployment and the media warning of an imminent US recession. Not even the Fed’s deep rate cut promise to significantly boost optimism since lenders have not passed the full easing onto consumers.
[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
Housing market data maintained the sector’s freefall this past week. A report from RealtyTrac revealed home foreclosures in the year through February jumped 60 percent while bank seizures over the same period doubled. The government only made matters worse when it released February’s building numbers. Housing starts slipped 0.6 percent, while permits plunged to a 16 year low. And, while these numbers seem discouraging, they may in fact suggest housing may be near a bottom. A damper on construction and falling prices will actually help to move stagnate inventory and in turn revive the market. Consumer-related companies continue to take divergent paths. Those firms tied to lending continue to suffer from sticky credit markets and a lack of demand stemming from the fact that consumer rates have yet to see the full pass through of the Fed’s aggressive policy easing. Along similar lines, home builders have seen little demand as the housing market maintains its worst recession in a quarter century. And, while many firms tied to discretionary spending have also seen their bottom lines tip into the red, discount giants like Walmart have seen sales spike as Americans seek cheaper prices.
Written By John Kicklighter, Currency Analyst at DailyFX.com
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