US Economic Outlook and Credit Market Difficulty Warrant Aggressive Fed Rate Cuts

Falling interest rates have done little to stimulate growth or to improve sentiment in the lending market. Credit default swaps rose to a record high Wednesday as testimony from Fed Chairman Bernanke and Treasury Secretary Paulson last week rung in investors’ ears. With the Fed expecting worsening conditions in lending and growth, demand for credit will struggle.

Short-term money market assets struggled through another week of falling rates. Demand at the short-end of the yield curve persisted thanks to demand from lenders looking to cover their long-term liabilities with short-term debt. With rates LIBOR rates testing new, multi-year lows, it is clear the market is calling on the Fed for another aggressive rate cut in March.

Breaking the Dow down, there were few sectors that were bucking the market’s bearish momentum. However, there were a few standout underperformers in the mix. This past week’s consumer-centric data hit the retail sector disproportionately as vital domestic consumption threatens to plunge faster than the rebound in foreign orders can fill in. The other, hard hit sector was the Financial group. A few, new writedowns from major banks suggests there is still a considerable pool of assets out there that have yet to be assigned a market-calculated value.

Though the broad market as rather reserved in its weekly decent, the financial sector was looking at substantial losses. The top fundamental headline for group were reports that major bond insurers would split, leaving the credit rating on their core business safe and allowing the subprime and hard hit ABS groups to fend for themselves. While this would salvage the overall firm’s credit rating, it would also almost certainly lead to significant downgrades on $580 billion in assets and further roil the credit markets.