special reports

Credit conditions seemed to improve over the past week as a clear rebound in risk appetite has encouraged borrowers and lenders to bridge the gap the wide spreads that have developed. However, the credit market’s correlation to broader financial trends may break down rather quickly over the coming week considering the forces working against it. On Tuesday, the Fed released the results of its sixth injection of liquidity into the unstable money market under its Term Auction Facility program. The $30 billion in funds available to commercial banks received total bids of $67.96 billion, suggesting the demand for credit still hangs heavy over the market. What’s more, Fed Chairman Bernanke’s testimony before the Senate highlighted the policy group’s expectations for worsening financial and economic conditions.

The risk premium in the debt market has retraced markedly over the past week. The cost of insuring companies’ solvency through credit default swaps fell as news that the market’s largest bond insurers would not have their credit ratings slashed hit. A number of banks will reportedly inject Ambac with liquidity while the S&P group reportedly took MBIA off its credit watch list.

Money market assets eased off their sharp plunge, but yields have yet to put in for a notable advance that may signal an end to the selloff is nigh. What’s more, with Bernanke’s testimony before the Senate focusing on a dour outlook for the economy and comments clearly keeping the door open to further rate cuts, yields across the curve will likely have further to fall.  

Despite a build up of disappointing economic indicators over the past week, US equity markets clearly under the control of ardent bulls. The benchmark Dow Jones Industrial average climbed nearly 2 percent to mark a possible double touch with the test of 12,750 marked at the beginning of the month. However, whether the market can keep its upside momentum or not will likely depend on how this past week’s headlines influence expectations for an economic and financial market recovery. Earlier in the week, news that the monoline insurers were taken off the credit rating chopping block raised hopes for a rebound in lending and capital investment. However, the long-term impact of this good news will certainly be put to the test as scheduled economic data steadily revives concern over the future of consumer demand and therefore revenues. Fed Chairman Bernanke’s testimony before Congress is particularly concerning, as he expressed fears over growth and inflation.

While the broad equity market has advanced over the past week, certain sectors were advancing with more zeal than others. In a clear contradiction of economics, the retail and real estate groups marked outsized rallies over 3 percent apiece – despite indicators that reported a 13-year low in new home sales and the most pessimistic consumer confidence reading in five years. At the same time, the financial index lagged in its advance even though the security of the largest bond insurers held the greatest promise for lending institutions and banks.

The advance within the battered financial sector has been uneven. News that MBIA and Ambac would not have their top credit ratings slashed offered a much needed boost of confidence for commercial lenders and investment houses; but the constant threat of volatility in the financial markets proved too ominous for investors to confidently back the market’s turn of faith. Now, with earnings season and a fresh round of writedowns not set to begin until April, the financial sector will likely follow credit conditions and data for the coming week.

Dismal results from recent Conference Board Consumer Confidence data have intensified fears of a pronounced consumer-led recession, and outlook remains dim for overall consumption rates. Further falls in housing indicators have had similarly detrimental effects on spending forecasts, and there can be relatively little doubt that the US Federal Reserve stands ready to counteract such effects with further monetary policy accommodation. Given overall trends in labor and housing data, markets are very clearly discounting further Fed rate cuts through the medium term. Any noteworthy improvement in housing, labor, or confidence numbers could reverse such trends, but we do not expect any such improvement for quite some time.

MBA Mortgage Applications continued their incredible volatility through recent weeks, falling an incredible 19.2 percent in the seven days ending February 22. Such week-to-week jumps arguably underline the stresses in the domestic mortgage market, and the elevated levels of MBA Mortgage Applications highlight difficulty in obtaining credit. Recent housing market indicators have remained relatively stable, but risks continue to remain for a persistent US housing recession. Outlook for the domestic homeowner looks dim in the absence of a clear improvement in US real estate trends.

Walmart shares continue to outperform broader equity markets, and the discount retail conglomerate has just recently set fresh 16-month highs on a broader equity market rally.  Previously bullish earnings data suggests that the discount retailer may be able to withstand bearish momentum for the retail sector. Home improvement company Home Depot has not been nearly as fortunate, and persistent pessimism on domestic housing trends may potentially force further losses in the company’s shares. Seen through relevant stock indices, markets remain bearish on prospects for the domestic consumer.