All Signs Point to Further Fed Rate Cuts

It was too early to see the effects of the Buffet offer and Treasury Department-led effort to help mortgage holders near default on sentiment in the credit market. The risk of default measured through swaps jumped nearly 19 percent week over week. And, even though the risk premium in junk bonds was only moderately changed, it had still resumed its uptrend.

Conditions in the short-term money market are still very tight. The Fed’s recent term auction facility injection clearly signaled heightened demand for liquidity. Elsewhere, the LIBOR and T-Bill rates across the lower end of the curve continue their drop as banks keep their capital in the short-term, highly-liquid and low risk assets.

The start of a new week has brought renewed hope for perennial equity bulls. Since Monday, the Dow Jones Industrial Average has put in for three consecutive – though modest - advances. This rebound in confidence has been won by a brut force: steadily improving economic indicators and a string of promising news headlines that have dampened the threat of sustained volatility and large investors abandoning the risk seen in holding stocks. This week’s economic calendar was highlighted by the government’s January retail sales report which signaled an unexpected rebound in consumer spending after the worst holiday shopping season in years. Further providing support for the tentative rebound was news that well-known investor Warren Buffet was offering to take on $800 billion in liabilities from three troubled bond insurers. However, despite this promising news, the advance in equities remains a cautious one as another disappointment from earnings or sign of the subprime infection could easily spark another decline.

While the benchmark indexes have all turned higher, the positive turn has not manifested itself in a number of the major (and perhaps crucial) sectors. The highly sensitive financial index continued to fall through the week – suggesting the outlook for the lending and growth would not improve on a mere increase in retail sales. The commentary from the G7 this past weekend, that the US economy will likely cool further, certainly has broad implications for the entire economy and for global growth as a whole.

There was little additional improvement in the financial sector over this past week. On the earnings front, Credit Suisse Group’s fourth quarter numbers maintained the pessimistic outlook for the world’s largest investment houses. Switzerland’s second largest bank reported a 72 percent drop in profit and an additional $1.2 billion write down. Looking out over the coming week, Warren Buffet’s offer to take on a hefty chunk of troubled bond insurers’ liabilities and talk of a 6 firm plan to help borrowers will likely determine the sector’s direction.

MBA Mortgage Applications continued to surge through the middle of February, with the number of requests for mortgage credit reaching their highest since March, 2004. Such surges nonetheless coincide with further gloom in the broader housing market. We continue to argue that such strong rises in MBA Mortgage Applications are a function of tight credit markets—not of rebounding housing demand. As banks grow wary of extending credit, consumers are forced to re-apply for borrowing.

A relatively directionless US stock market has allowed Walmart shares to continue climbing towards 52-week highs, and there seems to be relatively little in the way of further Walmart rallies. Indeed, it seems as though speculators predict that the discount retailer will outperform the broader market on a potential US economic slowdown. Home Depot shares have not fared nearly as well, and indeed they remain near their lows on continued fears on the current housing market recession.