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Beige Book, Treasury Issuance, Corporate Defaults

The Federal Reserve found general, modest improvement from depressed levels. A burgeoning TIPS market?

BusinessWeek compiled comments from Wall Street economists and analysts on key economic and financial market topics on Oct. 21:

Action Economics

The Federal Reserve's Beige Book released on Oct. 21 reported "stabilization or modest improvements in many sectors," though often from depressed levels. Residential real estate and manufacturing were the more positive sectors of the economy that were helping the recovery. Reports on consumer spending and nonfinancial services were mixed, while commercial real estate was one of the weakest sectors. Transportation activity generally declined. Tourist activity was varied.

The Beige Book indicated that there were more reports of gains in activity than declines, although nearly every reference to improvement was qualified. That's consistent with what we've seen from the data and heard from Fedspeak. Regarding wages and prices, Districts generally reported little or no increases, but there were occasional references to downward pressures.

Edward McKelvey, Goldman Sachs

Recent changes to our budget outlook now suggest a closer balance between the Treasury's current "run rate" of coupon issuance and its financing needs for fiscal year 2010 than we previously estimated. However, for subsequent years we still think the current volume of issuance is more than adequate. We therefore still regard further increases in coupon issuance as mainly a matter of choice rather than necessity for the U.S. Treasury.

In this regard, Treasury officials have indicated a desire to keep boosting coupon issuance with the twin objectives of lengthening the maturity of the debt and developing the TIPS market. Both make sense at a time of historically low interest rates and heightened inflation worries in some quarters. Accordingly, we look for TIPS issuance to rise to $70 billion in fiscal year 2010, from $56 billion in fiscal year 2009, and increased nominal issuance—mainly of [2- and 10-year notes]—to boost total gross issuance of coupons (including TIPS) to $2.38 trillion, from an estimated $1.81 trillion in fiscal year 2009.

Chris Scicluna, Daiwa Securities

The latest Bank of Japan senior loan officer survey of bank lending practices supported the view of the BoJ that the recent fall in bank lending largely reflects weak demand for lending, rather than an unwillingness of banks to supply credit. The survey showed demand for loans from firms and households weakened in the past quarter, much as in Q2. This was equally true of small enterprises as large enterprises. The reasons cited for the lower loan demand included falling sales, lower demand for investment and a shift in the source of funds.

Meanwhile, the survey also revealed that over the past quarter, bank credit standards had become easier for households and all sizes of firms.

Diane Vazza, Standard & Poor's Ratings Services

[T]he tone in the capital markets has improved measurably, resulting in benefits for even low-rated borrowers. Accordingly, we have revised our default-rate expectations for the next 12 months downward. This does not mean that corporate default risks are permanently lower. Instead, we believe these improvements as largely being driven by increased forbearance by lenders in a monetary environment propped up by policy-induced liquidity. Without a revival in top-line earnings and growth, many of the surviving leveraged issuers originated during 2003-2007 could face renewed default risk unless they significantly reduce their debt burdens.

The projected drop in the corporate default rate conveys a greater sense of foreboding than it does genuine relief. As a result of lenders' willingness, a number of distressed issuers have simply been able to postpone default in the near term by using strategies that include bond-for-loan takeouts, loan extensions, covenant amendments or resets, and equity issues.

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